The Wall Street Journal-20080202-With Starbucks- Investors Need Patience
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With Starbucks, Investors Need Patience
Full Text (839 words)Investors looking to cash in on a turnaround at Starbucks Corp. shouldn't expect results soon.
Wall Street cheered the return of coffee pioneer Howard Schultz as chief executive last month, bidding up the company's battered stock price, which had slid nearly 50% during the previous year. But investors looking for a bargain should proceed gingerly.
Everyday investors can get tempted by once-hot brand names that look cheap. Many don't realize how long it can take to right the ship, and how rocky the sailing can be during that time. Companies like Gap Inc. and Home Depot Inc. have spent several years trying to get back on track after losing their way, and their stocks have sputtered.
At Starbucks, investors are concerned that Mr. Schultz's turnaround plans are going to unfold slowly and vaguely. When he took over last month, Mr. Schultz pledged to give more details of his strategy when the company reported earnings on Jan. 30. Instead, he ended up taking away some critical metrics that investors use to gauge the stock by saying that Starbucks would no longer disclose same-store sales and that the company's long-term earnings guidance would be put on hold.
What is particularly tricky about handicapping a Starbucks turnaround is that the company has built its brand on something intangible: an upscale aura for coffee, a product that had long been a commodity. Getting that aura back isn't something investors can easily quantify.
"There are no quick-fix solutions," Mr. Schultz said in an interview. "It will take time."
Investors who follow the coffee giant know this already. But what individual investors may be overlooking is just how bad things could get during the turnaround, and just how little visibility they will have as to the company's progress.
Consumer spending remains under pressure from weak housing prices, and Starbucks faces increasing competition from, among others, McDonald's Corp., which plans to start selling espresso drinks -- Starbucks's signature product -- at U.S. stores this year.
Mr. Schultz tried to reassure investors Wednesday by promising more turnaround details at the company's March annual meeting, including five of what Mr. Schultz called "consumer-facing initiatives." Past annual meetings have been scant on investor news, instead showcasing Starbucks's new music artists with live performances from stars like Tony Bennett.
Goldman Sachs analyst Steven Kron had expected Starbucks to take the money it saved from cutting new store growth and buy back stock. But on Wednesday, the company said some of those savings will be offset by spending on new innovation.
Mr. Kron, who has a "neutral" rating on the stock and whose firm owns shares in and does banking for Starbucks, predicts the shares, which closed up 1.6% at $19.22 Friday on the Nasdaq Stock Market, could trade as low as $17 a share in the near term. Starbucks stock trades at 18.5 times estimated per-share earnings for 2008, according to Thomson Financial.
UBS analyst David Palmer, who has a "buy" rating on Starbucks, said he expects it may be summer before investors see sales pick up meaningfully, and that the real test will be how strong Starbucks's new line of summer drinks is. "The danger is that the multiple can compress somewhat from here . . . if these initiatives don't resonate with investors," says Mr. Palmer, whose firm provides investment- banking services to Starbucks.
Mr. Schultz's decision to refocus Starbucks on its customers also should benefit the company in the long term. But it also means that the company will remove some of the levers that have historically driven the stock. For instance, the company's hot breakfast sandwiches, which Mr. Schultz said the company would remove from stores this year, were adding $35,000 a year in sales to each store that sold them. Mr. Schultz warned investors the change could slow sales growth. "We realize that embracing the status quo isn't going to be the road that we travel," he said.
Some investors have drawn parallels between Starbucks and McDonald's. The hamburger chain staged a swift turnaround five years ago by cutting back on expansion so it could fix its existing restaurants. But Starbucks's strategy is shaping up differently. While McDonald's all but stopped building new locations, Starbucks still plans to add more than 2,000 outlets this year. McDonald's also overhauled its marketing and redirected its massive advertising budget toward a crisper message to win back customers.
Starbucks was one of the first major consumer brands to be built using word of mouth -- and there are few precedents for how to resurrect a tarnished brand that was built that way.
Other improvement strategies could take a while to execute. In explaining Starbucks's decision to test $1 coffee, Mr. Schultz said the company is looking at "segmentation" strategies that would provide an entry point for new customers amid a weak economy. Starbucks does have other brands, like Seattle's Best Coffee. But expanding that would take time, and adding a lower-priced tier inside its own stores would be tricky for a brand that built its reputation on upscale cachet.
