Thursday, June 28, 2007

Starbucks: It's a Matter Of Price

Here is a post from Georges Yared that references my Starbucks (SBUX) post from June 21st. In it he disagrees with my opinion people avoid shares now and I think does a wonderful job laying out his reasoning.

Mr. Yared finishes his post saying "I believe Starbucks can earn $.87-.88 for this fiscal year ending September 30th and $1.08-1.10 for fiscal year 2009. Cost management without sacrificing the customer experience is vital to its success and ultimately its stock price. Starbucks has never missed a quarterly expectation...yet. The stock still carries a premium multiple, deservedly: but it has to be earned every quarter.

Starbucks needs to weather this storm and resume its growth trajectory if it has any hope of attaining a $50 billion market cap and beyond. The first hurdle must be cleared.

I believe the stock is a buy here at $26 for the patient investor. With execution of its detailed business and growth plan, the shares should maintain a premium valuation and look for a $35 price target over the next 9-12 months."

I do not think we disagree very much. On May 18th I wrote:

"So what price then? Shares have to fall substantially from here before anyone should consider them. As the chart below illustrates, Starbucks has traditionally sold at a slight premium PE (1.25 to 1.5 times) to it's growth rate.

eps % PE ratio
1996 20 50
1997 50 49
1998 22 46
1999 27 50
2000 29 47
2001 28 45
2002 22 39
2003 21 36
2004 41 40
2005 27 43
2006 20 46

Of the times it did sell at more than that (2+ times), the following year featured increasing growth "justifying" that "froth". The aberration in the PE vs. growth rates trend has been from 2005 on. 2006 featured dramatically slowing growth for the second consecutive year and an increasing PE over the same time span. This was the genesis of my original post (in January) and shares since then have acted accordingly down 20%.

With that rate at this year at MAYBE 18%, its current 31 PE has shares grossly over valued. A price range of $22 to $27 put us in a historic PE to Earnings Growth range. Now, that also assumes they hit the 18% EPS growth this year which I am doubting more as each day passes.

With all the uncertainty surrounding the company at this point, I could not even begin to consider shares at any price other than the lowest end of the range, $22 or another 21% lower than current prices as I expect EPS growth to slow more."

When I wrote that, shares sat at $29 and now have fallen to $25 to $26 range. While I do agree with Mr. Yared that Starbucks has wonderful growth potential, I do feel shares will continue to fall during the summer and may collapse (if only briefly) if Starbucks misses this quarters earnings estimates. I think this is a very real possibility. I still would be a buyer in the $22 range but would be reluctant to jump here.

Now, if word got out that CEO Jim Donald was being asked to find employment elsewhere, that might be enough to get me to bite at these levels. Barring that, I'll wait.

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