Starbucks: Add a Caffeine Shot to Your Portfolio

After hitting a high of $40/share in early October, Starbucks (SBUX) has fallen to a current value of $25.87, down 35% and is at a 22-month low. Why is this stock down so much?

1) In late June, the CFO of Starbucks was quoted that the high end of 2007 earnings forecast ($.87-$.89/share) “will be very challenging” to attain due to:
a) rising price of milk (which is directly related to the increase in ethanol production)
b) slowing sales growth in US Starbucks locations

2) Increased competition from other competitors getting into the coffee business such as McDonalds (MCD) who has a premium coffee that has received positive reviews.

Reasons for optimism:

a) Starbucks says that China will be the biggest market outside of the US and will increase international stores by 20% over the next few years. Key growth will be outside of the US in markets that Starbucks has yet to establish. Locations in Russia and India are poised to open later this year. Americans already knows what to expect out of Starbucks when you go to the one of 6,281 Starbucks locations. The goal is to get a foothold in Chinese, Japanese, and Brazilian markets as soon as possible.

b) Adding more drive through locations is a no-brainer. As of October 2006, Starbucks operated 1,600 drive through locations. Life is so fast-paced here in America that sometimes people just want to pay for their $4 latte and get on with the rest of their work day. Some people don’t want to deal with the long lines inside the store and hassle of carrying coffee to their car. If America wants coffee on the go, then that’s what she’ll get.

c) Peet’s Coffee (PEET) isn’t considered direct competition for Starbucks, but Dunkin’ Donuts is probably the closes competitor. These two chains target entirely different demographics. Dunkin’ Donuts was originally founded in 1950 in the Northeast (Quincy, Massachusetts) and appeals more to the lower/middle-class America that is looking to get a cheap coffee and a more down-to-earth experience. Dunkin’ Donuts operates 6,000 shops worldwide compared to Starbucks 14,000.

d) Modification of their food menu because sometimes people don’t want just coffee. Customers sometimes need some sustenance to go with their coffee and Starbucks has delivered recently. Additions to their lunch menu with new items including a tomato mozzarella salad, fiesta salad with grilled chicken, roasted corn and black beans, bowtie pasta with goat cheese, and Asian sesame noodle salad. To cater toward the health conscious consumer, McDonalds did an overhaul of their menu over the last few years including salads, premium chicken sandwiches, negating the supersize option, and offering other healthier options. McDonalds stock price has doubled over the last three years and their upward momentum appears to be continuing. Starbucks understands that they are not just a coffeehouse anymore.

Benefit or downfall?
Starbucks has over 14,000 stores open around the world and aims to have over 40,000 stores in existence for the long term (with over half outside of the US). But some say that with so many stores open this will dilute the appeal of a Starbucks coffee and saturate its image.

The way I see it, if Starbucks can open stores across the street from each other, then they can handle losing the “novelty” label. They cater toward a crowd that is looking for a pleasant ambiance and a casual place to have a drink with a friend, conduct an interview, work on your laptop during lunch, or just have a place to cool off during summer.

Starbucks is at a discounted price and I believe will have more upside potential with minimal risk. Target price: $33

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