Starbucks (SBUX): Running Out Of Steam Or Ready To Perk?
As Starbucks gets ready to announce quarterly earnings on Wednesday, opinion is divided on whether the chain is running out of steam or is ready to perk.
In today’s Wall Street Journal, breakingviews advises investors to be wary despite an expected lift in profit margins as a result of a 9-cent price hike. Before Thursday’s selloff, Starbucks shares already had lost more than 20% of their value this year.
Part of the Starbucks problem has been a profit squeeze. Prices of almost everything needed to run a coffee house — beans, real estate, labor, milk — have been on a tear. As a premium brand, it is only natural for Starbucks to pass some of these expenses on to its customers. Deutsche Bank reckons the price increase could add a penny to Starbucks’s per-share earnings next year. That might not be enough to lift Starbucks’s stock out of its slump. At 26 times estimated earnings, the shares may appear a relative bargain compared with the 50 times earnings or more that it fetched earlier in the decade, breakigvews says. Even with the shares decline, Starbucks’s stock still is pretty rich. To justify the earnings multiple, Starbucks needs to beat the wider market’s earnings growth rate by 10 percentage points or so for the next five years. Its shares may not be as expensive as they once were, but Starbucks’s valuation is too robust to leave room for error.
On the other hand, Business Week reports in its Aug 6 issue that Starbucks may have bottomed in the view of some pros, including Georges Yared of Yared Investment Research. He sees the stock snapping back as management takes steps to regain lost ground. One catalyst is Starbucks’ breakfast sandwiches. Yared figures the breakfast fare will add $70,000 to each store’s annual sales. That’s about $200 million total a year, he says, and it’s not yet reflected in estimates. He sees earnings of 88 cents a share on sales of $9.5 billion in the year ending Sept. 30, 2007, and $1.10 on $11.5 billion in 2008.
Joseph Buckley of Bear Stearns says the market is focused on near-term negatives and ignores Starbucks’ strengths and prospects. “This is a more appropriate time to buy than sell, and we reiterate our outperform’ rating,” he says. Dan Gelman of investment firm McAdams Wright Ragen rates the stock, now at 27.96, a buy, with a 12-month target of 44.
Research from William Blair and Co. in May noted that Starbucks valuation premium relative to other restaurant chains was at an all-time low and offered some further thoughts in late June after meeting with Starbucks management. Piper Jaffray reiterated its Outperform rating earlier this month while in June RBC Capital Markets saw signs that sales were warming up, while ThinkEquity partners reported signs of margin presure. more recently, CIBC World Markets looked at the impact of the July 31 price increase.
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