Starbucks Management Refuses To See Reality?

It is hard to believe that CEO Jim Donald still has a job...

For the recent quarter ended Sept. 30, Starbucks (SBUX) posted net earnings of $158.5 million, or 21 cents a share, compared with $117.3 million, or 15 cents a share last year. Quarterly revenue was up to $2.44 billion from $2 billion last year. Analysts surveyed by Thomson Financial were projected 21 cents a share on $2.43 billion in revenue. Starbucks said it expects earnings per share in the next year of $1.02 to $1.05 a share, at the low end of the current $1.05 estimates.

For the full fiscal year, Starbucks earned $672.6 million, or 87 cents a share which was at the low end of the 87 cents to 89 cents the company predicted. It was not until July the company lowered expectations to the 87 cents a share.

The news that really mattered? A 1 percent drop in traffic, the first decrease since the company started releasing those numbers three years ago. On Thursday I said that Starbucks would post "flat to negative transactions".

CEO Jim Donald said the 1% dip in average transaction per store in the U.S., the first decline since Starbucks started disclosing this measure of customer traffic about three years ago, isn't a sign that the company has built stores too quickly or that the market is showing signs of saturation. "The saturation comment's overblown," he said.

For once I agree with Mr. Donald. Starbucks has not over-saturated the market with physical stores. What they have done is over-saturated the market for $6 lattes. Starbucks will not see this trend turn around until consumers perceive value in their products. Currently they do not. For whatever reason, management still believes that their products is not a discretionary item and when things get tight, those items are the first to go.

This could be an easy fix for Donald. Instead of raising prices and further shrinking your market, lower them and expand it. They raised prices twice last year and it just has resulted in less people coming in the door. I can't be the only one who sees this. Donald as much admitted this in an interview when he said that a July price increase of about $0.09 a cup hurt traffic. It is like sticking a fork in your eye and then wondering why it hurts.

Mr. Donald said Starbucks, like other retailers, is feeling the effects of pressures on consumer spending. Also, a sharp rise in dairy costs this summer caused the company to raise prices for the second time in less than a year. "We're seeing this economic impact not just in select states across the country but...coast to coast," he said. No kidding. If I were a shareholder I would really want to know why until late summer they were sticking to their 89 cents a share forecast and denying milk prices were an issue despite as my warnings as far back as May.

The main problem here is that Donald has lost all credibility. He is telling investors it is sunny out when they are standing in the rain. You just cannot believe what he or Schultz are saying anymore. It may not be an intentional lie, it may be far worse, they honestly may think that the laws of economics do not apply to their business. If that is true, there is no chance of this thing turning around anytime soon. With shares down almost 40% this year, more pain for investors is in store.

I will review the earnings call Friday and post on it.

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