Thursday, August 03, 2006

Color on quarter: Starbucks (SBUX)

Several firms are commenting on Starbucks (NASDAQ:SBUX) after the co released weaker than expected comp numbers and uninspiring guidance last night:

* Deutsche Bank notes store expansion and same store sales +6%, plus modest margin upside, drove a spot-on quarter. However, a slowdown in July same store sales stole the show as the introduced complexity from serving newer items slowed transaction growth. We expect the shares to react negatively to an emerging reality: growth may come harder as the company moves further away from its core coffee business.

Tomorrow will be only a modest reckoning: selling pressure in the shares by value players who no longer see value. Or short term reaction to a dim Wall Street view of weaker than expected July comps. Longer-term, we are concerned that this company may be transitioning from a great global grower with a unique, unassailable franchise to reactive, real estate 'reacher' that builds stores and adds non-core products to get growth, but does not quite have the means to sustain once the capital investment is made. The implications for returns are quite onerous. Firm notes they have never quite been able to reconcile how to make economic sense of the rapid store build. Qualitatively, it doesn't matter whether it's going up in Indonesia or Indochina. Growth zealots be forewarned: it's awfully hot in some of those BRICS (Brazil, Russia, India, China) management refers to as the growth portals for this millennium. And if Mr. Gore and others are right, it's getting warmer. Now that doesn't make me reach for a nice hot cup of coffee. Spot on quarter, but +4% July comp highlights valuation risk Despite the big headline miss on July same store sales (+4% vs. our +6% estimate), the quarter came in at firm's expectations, and broadly speaking, growth prospects are still attractive. In our view, the July comp highlights the risks we discussed in their initiation research- the potential slowing of domestic sales growth and the potential for revaluation of the shares to reflect it. Expects the stock to come in on this news, and possibly remain under pressure for the near-term, unless or until same store sales trends re-accelerate.

In short, they are not condemning SBUX as a broken story. Far from it. They are simply pointing out that this quarter's mixed news is a key example of why SBUX, at current valuation, is a risky investment proposition. No growth story is perfect, but they believe SBUX has been priced for perfection for some time. Firm expects some considerable downward pressure on the shares and volatility over the coming few months as the capacity constraint issue plays out and share valuation adjusts. At some point, they expect an attractive buying opportunity to present itself.

Firm is maintaining their F2007 ests, Hold rating but lowers $37 from $38.

* Bear Stearns notes they expect investors to treat the sales slowdown as a macro-related slowing. The 4% comp is the slowest since December 2001 and the first monthly same store sales gain below 6% since that time. Firm expects SBUX shares to correct sharply but would be a buyer on weakness. Notes that historically buying SBUX shares at 30x forward pre-option earnings has proved lucrative. Their pre-option FY 2007 EPS estimate is $0.98 ($0.87 post option estimate plus estimated $0.11 option impact) suggesting that $29-$30 would be an attractive entry point. The long term prospects for the company are underscored by another acceleration of expansion plans - FY 2006 openings were bumped to 2,000 and a FY 2007 goal for 2,400 openings was established. Firm continues to rate SBUX shares Outperform.

* Goldman Sachs notes the focus will be on the disappointing July SSS trend (4% versus GS estimate 6%) which showed further multi-year deceleration. The company offered an explanation which included bottlenecks in the AM daypart due to a greater sales mix of cold blended beverages. Firm believes economic factors are also to blame.

They expect significant downward pressure on shares today as the market establishes a new multiple reflective of a more modest SSS expectation (expect 4% for August). Importantly, the overall growth profile of the company remains unchanged as the company is accelerating unit development again in 2007. SSS slowdown notwithstanding, Firm is maintaining their Buy rating on shares. They continue to believe Starbucks' business fundamentals remain tops in the industry (return on invested capital of ~18%), growth opportunities, particularly internationally, remain robust and EPS visibility remains high. Firm has lowered their price target to $38 (from $44) and have made modest EPS revisions to reflect a more moderate sales outlook. New 2006, 2007, and 2008 EPS estimates are $0.72, $0.89, and $1.09, all down 1c from prior estimates.

Notablecalls: Must say I don't have a clear view what to do with SBUX here. The stock is a notorious bouncer but it seems people are becoming gradually unwilling to pay $4 for coffee. Macro issue. Think it may have some more downside in it. Would not be surprised to see a downgrade today or in the coming days.


dcxavier said...

I agree that it is a Macro issue hitting the middle/upper-middle class. Check recent guidance from CAKE, PFCB and WFMI too. All represent highly discretionary purchases, easiest to cut.

notablecalls said...

Don't forget RL and GPS. And TIF. Of these I think RL makes the most sense as a short.