Starbucks Wakes Up, Smells the Coffee

Starbucks (SBUX) announced a major change of course yesterday when the hyper-expansive coffee retailer announced that it will shutter 600 under-performing stores and lay off as many as 12,000 employees as it comes to terms with an unexpectedly difficult operating environment. CEO Howard Schultz, who built the iconic company from its Seattle roots into a national chain and one of the most recognizable brands in the world, recently was brought back to try to rekindle some of the magic as the company’s shares have fallen over 60% from their all time high reached in 2006 and are now trading at levels not seen in five years.

Schultz has been working frenetically to turn things around at Starbucks. Since his return to the helm, SBUX has dropped breakfast items from its menu, announced a reduction in planned store openings and the closure of 100 under-performing, company-owned stores. Yesterday’s announcement demonstrates a greater sense of urgency as the once high-flying retailer adjusts to a tough economic environment.

It is becoming clear that Starbucks’ coffee drinks are indeed viewed as more of a luxury than a necessity and are being avoided by beleaguered consumers who have to deal with rising inflation in gas and food prices. In such an environment and having tried unsuccessfully to build meals into their product mix, SBUX has limited options to turn things around quickly. Also, Standard & Poor’s announced today that it would review Starbuck’s credit rating for a possible downgrade (it currently is rated BBB+).

With all this bad news, what appeal do SBUX shares have to investors? For starters, the stock’s valuation is quite compelling. Starbuck’s current price-to-cash flow is 9.64, while its historic range is 15.4 – 25.4. Its current price-to-sales is 1.13, while its historic range for this metric is 1.95 – 3.2. Were the stock’s price-to-cash flow and price-to-sales numbers return to the lower end of its historic range, the stock would trade back to the mid to high twenties.

Secondly, overseas growth offers a potential for SBUX to regain some of its lost glory. SBUX plans to open 1,000 stores in foreign markets this year and the foreign marketplace is not cluttered with competition (both internal and external). Overseas expansion, combined with a greater focus on profitability in the U.S. market could be just the brew to stem a bad run for SBUX share owners.   Ockham Research maintains our buy rating on SBUX shares.

Comments

[ponchovilla]

Starbucks: Simple choice 1 gal of gasoline (diesel) or 1 cup of el grande frappe dumbo. Let's see how the customers choose. There's plenty of time.
Your data is reflects the past. How confident are you that it will pass a stress test?

[startouch]

Is it wise to base ones investment on 'historical metrics'?
I visit SBUX stores 5x a week and only lately am always first in line.
I have not seen any changes in atmosphere, offerings and other things that Schultz needs to correct. I think it might well become a 'has been'. I am now switching to a smart local outfit and am happier for it.

[User 234287]

What site is that chart from?

[Ockham]

That chart comes from our actual SBUX research report at the time of this article.