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Nasdaq darling Starbucks (NASDAQ:SBUX) saw its stock price tank on Friday to a new 5 month low of $47.47 after warning that it would miss full year earnings forecasts. This is not a bad company but I fear its problems are just beginning and as such the shares are still a sell. Short Starbucks – target share price $35 (for starters).
I guess you all know what Starbucks does. It sells pretty bland, milk-filled coffees and a range of other products that do nothing for my diabetes on a grotesque gross margin. It is a brand that does not need to promote itself, we all know Starbucks. Some folks hate it as a symbol of big corporate America. Others love it while most of us treat it with a vague indifference. If I want caffeine I really do not care who serves it up.
In the third quarter, ended July 1st, revenue rose by 13% to $3.3 billion. The Americas (largely the US) accounted for $2.47 billion of that, reporting an increase of 9% in revenues. In its heartland region the company managed a 2% increase in prices, a 5% increase in like for like sales with new stores chipping in the rest. But there was a warning that sales growth became increasingly tough as the quarter progressed and that this trend has continued into July.
And that is the issue. While Starbucks can still find the odd new place to open new outlets in the Americas ( it opened its first branch in Costa Rica in Q3) the scope for roll-out is pretty limited with the chain having to move into ever more marginal locations. So growth can only come from pushing up prices and comparable volumes. Ultimately Starbucks serves up a commodity product earning a massive gross margin (and which can therefore be undercut). So why should its sales growth outstrip GDP growth? I suspect that in “good” times folks may always have that extra latte and do not care about price. In tough times this is one of the cheapest luxuries to either cut out, cut down on where one can maintain consumption levels by switching to a cheaper brand.
Since it is quite clear that the US economy is being dragged down both by its own problems and also by those elsewhere on this planet I would regard it as a slam dunk cert that revenue growth will slip again and by far more than the company or Wall Street analysts may wish to consider.
Outside the Americas, in Europe the Middle East and Africa revenues grew by 9% to $282 million. That all came from new stores. There were no price increases and underlying sales growth was nil. I make two observations here. Firstly, the European economies are all buggered and as such what I noted above about the US applies in spades over in the Old World. And secondly the deranged lefties who seem to control the European mindset will increasingly blame America (indeed everyone but themselves) for their woes and I suspect Starbucks will – as a symbol of America – suffer adversely from that. As for the Middle East, the number of countries where America is NOT seen as the Great Satan seems to reduce steadily. Again, the chances of even standing still look remote. Just how many Starbucks outlets are there in downtown Tehran these days?
As for China and the Pacific this was the Q3 growth story – revenues were up by 31% at $181.8 million. That was largely driven by new store openings (there are now 600 Chinese outlets) but also by a 4% increase in prices and an 8% increase in underlying business. But as I have noted repeatedly here the Chinese economy is a couple of months into what will be a very hard landing indeed – you can check out the evidence HERE and HERE and HERE. My guess is that the PRC started falling off a cliff in April. It takes a while for this to filter through into the real economy, that is to say Chinese buying fewer lattes but as the latte sipping classes do their conkers (when the mega property bubble bursts and the Chinese stock market tanks) we can safely assume that like for like sales growth will slump ( again if the economy grows at 3-5% this year and I do not reckon it will achieve even that, why should comparable sales grow at 12%?). We might even see some of the 600 stores which are marginal right now start to lose money and have to close. Certainly net rollout will slow.
So I cannot see how sales growth rates can hope to be maintained in any of the three geographic market segments but it is the mature US market where the damage may really be felt. Starbucks now forecasts that results for the year to end October 2013 will see earnings per share of $2.04 to $2.14 – growth of 15-20% over this year. That is predicated on an aggressive rollout programme ( much of it in China) but also mid single digit comparable growth to give overall sales growth of 10-13% ( up from 10-12% in Q4 of this year). I have doubts about the rollout. I think the target on like for like growth is just plain unrealistic.
At the bottom end of the company’s forecasts, the shares trade on a 2013 PE ratio of 23.3 for earnings growth of 15%. I reckon Starbucks will miss its earnings forecasts for next year, just as it has already admitted it will do for 2012. As such you may well be paying a 2013 PE of 25-26 for a stock delivering very low teens earnings growth. That is far too much, especially for a company with gross margins that are in the long run unsustainable and which now has form in terms of missing forecasts. At $35 on my forecasts you are still paying a 2013 PE of c18 which looks pretty full to me. Starbucks has to be a sell.
Incidentally if you are looking for a share tip on the long tack ( UK small cap) you will find one such tip here. It will go out during market hours and I shall alert anyone who cares via twitter. Sign up to follow me @tomwinnifrith for that alert plus a tweet any time any article by me appears anywhere else. Now back to my cafe frappe – not from Starbucks.
