Tuesday, June 12, 2007

Goldman Actually Makes Deutsche Look Reasonable (SBUX)

I do not really know where to go with this. I had to read it a couple of times because I thought I was missing something

Goldman Sachs (GS) today reiterated it's "buy" rating on shares of Starbucks (SBUX) but removed it from it's "conviction buy" list. They replaced it on the list with McDonald's (MCD). Now is Starbucks CEO Jim Donald finally "considering the competition"? I am not sure if this means shares of Starbucks are definitely a buy or not. It sounds like they are saying "we are pretty sure you should buy this, but not really sure."

This is on the heals of Deutsche Bank's call last Friday essentially saying the same thing. At least DB has Starbucks rated a "hold" and is not telling people to go buy shares.

Here is where the Goldman call gets odd (as if it is not already). In their note, they say that that they maintain a price target of $43 (almost 60% higher than they are now) based on a multiple of 36 times 2008 earnings (year end October). 36 times 2008 earnings? Even if Starbucks hits it's goal of 18% earnings growth this year, which is looking less likely everyday, and would be the third consecutive year of earnings growth decline, what make then think investors will pay such a high multiple? That multiple also assumes Starbucks grows earnings 25% next year, a number they have not hit since 2005. What impetus is there for this turnaround?

When you consider coffee prices are increasing, milk prices are at all time highs (and the real reason for the switch to 2% milk) and it is clear to everyone except folks in Seattle McDonald's is taking customers from them left and right, how could any reasonable person think they are going to report anything but "challenging conditions" in August when they release earnings and give future guidance? If they do manage to meet the earnings estimates, will it be be due to another $500 million share buyback like the one they did in Q1? Again, I will reiterate, I love share buybacks, but Starbucks just cannot afford that much each quarter.

I guess the question we need to ask is not why doesn't Starbucks deserve a multiple of 36 times earnings, but what justification can anyone give for claiming they do?

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