Thursday, November 15, 2007

Starbucks Still In Denial

"We only have 10% of the US coffee market" says Starbucks (SBUX) Chairman Howard Schultz. So, by that logic ought we expect 18% growth from Mercedes because they only have 3% of the US auto market? Me either and thus the problem with Starbucks

I would be willing to bet they have 95% of the US coffee market that would be willing to pay $5 for a latte. That being said, we now have Starbucks's central issue. The market they are selling to is only a fraction of what they think it is and they have virtually tapped out that smaller market. Schultz & Co. cannot continue to promise 18% to 20% growth when the number of people in the US they are serving has been stagnant for the current year. Consider the following chart from the WSJ.

Some folks have made the case that Starbucks grew too quick and saturated their market. Quite the contrary. They still have the same number of locations in the US as McDonalds (MCD) but the different is the coffee is more than twice as expensive. How could Mercedes increase their market share? Lower the price of the cars. How can Starbucks? Lower the price of its coffee.

Starbucks is caught here though between market share, maximizing ever penny per cup and growth. They have promised to expand to 40,000 stores and to back off that would scare investors. This is the problem will such bold predictions much like Home Depot(HD) is seeing with the shares repurchase plan, if you can't deliver, people are less than pleased with you. This causes management to fight reality. Always under promise and over deliver.

When you have two products that are similar, price and convenience always win. Now, does McDonalds have the "super premium" blends and the variety of drink offering Starbucks has? No. But what they do have is a very good product at very reasonable prices. What they have done is take a huge segment of Starbucks current and potential customers who are looking for value.

If you look at the chart above one thing has to stick out, Starbucks "no growth" periods in the US coincides 100% to McDonalds coffee improvement.

What to look for today? Transactions. Did they grow over last year and IF they hit their EPS number, was it due to the addition of debt to buy back abnormally large blocks of shares like they did at the beginning of the year.

My guess? Flat to negative transactions and an earnings estimate miss. The good news? They start coming up against much easier comps in the next quarter so the illusion of growth can at least be there for those investors still holding on.

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