Via iamamazing.wordpress.com:
Jason Kelly is the author of several books including one that I read many years ago called The Neatest Little Guide To Stock Market Investing. Yesterday Mr. Kelly had an article about Starbucks, one which I had a major problem with.
Is Starbucks A Buy?
July 19, 2007 | archives
Several subscribers wrote recently to ask about Starbucks. Is it undervalued at current prices, and worth buying?
I think so.
From its split-adjusted price of $4.50 ten years ago, SBUX rose 789% to $40 last November. It then declined steadily to $29 in early March, rose to $32 over the following two weeks, then declined to $25.50 on June 22. It closed yesterday at $26.50, a 3.9% gain from its low a little less than a month ago, but still 34% lower than its November high.
So, what’s the problem at Starbucks now?
Its chairman wrote in a memo that the company’s expansion from 1,000 locations to more than 13,000 has watered down its brand. That doesn’t bode well for plans to add another 1,700 U.S. locations this year. Some analysts project that the company will eventually top more than 30,000 locations worldwide.
Also, insider sales of stock by the chairman and other officers last year made some question the stock’s valuation. In retrospect, the officers were right to sell last year. Some are waiting to see them start buying again as the “all-clear” signal to begin investing.
The reason I think the stock offers more upside than down from here is that, despite its massive market footprint, Starbucks is in a business that has room to grow. Its many stores are not a negative, they’re a positive in the sense that the number two coffee chain in the U.S., Caribou Coffee, has fewer than 500 locations. Starbucks has 9,400 and will top 10,000 by year-end. Having twenty times the presence of its nearest competitor is quite an advantage.
As for concerns that the coffee business is saturated, I don’t share them. Neither does the Specialty Coffee Association of America, which pointed out that only 15% of adults in the U.S. drank a cup of specialty coffee each day in 2005. Too, Starbucks does a lot more than just coffee. It was brilliant at creating a menu with something for any kind of weather, and that brilliance has continued in all of its endeavors.
It faces challenges. Its ambitious expansion plans could go awry, especially in new markets like Brazil, India, and China. In the latter market, it already got into some trouble when it opened a store in the Forbidden City in 2000, only to close it under intense pressure last Friday when accused of trampling over Chinese culture.
Growing pains are inevitable, though, and it’s better to have them than not. They mean the company’s trying to grow, after all.
Another challenge facing Starbucks is increasing competition. Its biggest threat might be not from another coffee chain, but from McDonald’s, which is offering its own premium roast coffee. Other encroachers include Tim Horton’s, Dunkin’ Donuts, and Panera.
Of these threats, only Panera looks legitimate to me. Nobody thinks of hanging out and doing work or homework at McDonald’s. Tim Horton’s is just another coffee shop, and Starbucks has proven quite adept at crushing all comers in that category.
Panera, though, offers an experience that is comparable to Starbucks’s experience, if not better. I’ve worked on Panera’s free wi-fi network in the states, and it was excellent. The food is fantastic and the coffee is great. It’s a real restaurant and bakery that offers coffee, as opposed to a coffee shop that offers some baked goods.
That said, Panera is far, far behind Starbucks. It’s not as quick to get in and out, it’s not nearly as available with just over 1,000 locations, and its brand is nowhere close to being as recognizable as Starbucks’s. Plus, Starbucks has a lot more partnerships in place, with its brand appearing on grocery store shelves, airport kiosks, and on hair barrettes worn by high school girls in Japan.
All in all, I’d say the recent discount on SBUX presents an opportunity. I would hold out for $25 or less, a 6% drop from yesterday’s close.
Tomorrow: A long read ahead of the weekend covering the iPhone, U.S. health care, and Power Investor software. Don’t miss it!
What I didn’t understand was how he was valuing Starbucks. To me, buying at or below $25 may have been reasonable but I saw no analysis and figured it may have just been as arbitrary as when Jim Cramer shouts out random price targets, buy points, and what not.
To my pleasure and suprise this morning, Jason Kelly confronted my question in an article he wrote today and while I may not totally agree with his analysis, I believe it shows he has merit, something I started questioning yesterday. He wrote:
Starbucks
I wrote yesterday that Starbucks looks like a good value to me based on its dominant brand, good partnerships, and growth plans, and that I would look to pick up shares at or below $25. The stock gained 4.6% yesterday, thanks to my article and the market-moving power of my massive readership.
Well, it probably wasn’t just because of my article. It could also have had something to do with rumors that it would strengthen its partnership with PepsiCo and develop a premium hot chocolate drink with Hershey, as reported by Forbes.
One reader, Eric, called me to task for failing to justify my target buy price:
You say wouldn’t buy it above $25/share yet you make no reasoning for 25. Jim Cramer makes these claims all the time, “don’t buy company X under 100.” But Jim Cramer is more suited as an entertainer than an intelligent and rational investor. My question is why $25? Why not $30? Why not $23? Do you see my point? Your $25 seems like an arbitrary number, there’s really no real analysis behind it. I mean, I have no idea if you think this is a 50-cent dollar, a 30-cent dollar, or an 80-cent dollar. If I’m buying a shipping company for half of its ship’s scrap value, it’s clearly a 50-cent dollar or cheaper, but I have no idea about your reasoning behind Starbucks. Any explanation would be quite helpful.
Ah, just when I thought I could sail into the weekend.
Actually, Eric raises a valid point. I did toss $25 out there at the end of the article without explaining it.
The stock bounced off $25 and change twice in the past month. Throughout its history, SBUX has traded at a 1.25 to 1.5 multiple to its growth rate. It’s trying to hit an 18% earnings growth rate this year, but looks ripe for a disappointment. That makes me leery to jump right in, knowing full well that big pops like yesterday’s are always a possibility.
Run an 18% growth rate times a multiple of 1.25 and you get $22.50. Run it against 1.5 and you get $27. Take the average and you get $24.75, slightly less than the $25 I mentioned as my target.
Longtime subscribers know how I feel about targets. They’re flexible until I place an active order. I think Starbucks is ripe for a disappointment and that the stock could well get to the low-$20s before rebounding solidly and convincingly.
A chart-watcher wrote to tell me that the stock’s double bottom off the $25-ish range suggests that it won’t ever get to my sub-$25 target area. Funny thing is, that same chart-watcher told me the same thing about SBUX when it bounced twice off the $29-ish range back in March. Double bottoms don’t always hold, and it’s frequently worth looking beyond chart patterns.
I don’t think there’s a need to rush to buy Starbucks yet.
This weekend to subscribers: What the Fed said, why we’re sitting pretty in semiconductors, how we’re closing in on the stocks we’ve been watching so patiently, and more.
Next Week on this free site: Alternatives to my long- recommended Power Investor software, swing trading versus buying and holding, the accusation that my permanent portfolio strategies are “beyond ludicrous,” weaknesses in Google’s advertising platform, and more.
It’s all part of what one reader called “the best bargain in the business.” Tell your friends.
Have a great weekend!
$27.96 (07/21/07)
