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Is Starbucks still a short? I'm guessing yes. Here's why.

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December 03, 2008 – Comments (6) | RELATED TICKERS: SBUX

 

It's a well-known fact that shares of Starbucks have been absolutely torpedoed (man I love that word) lately.  SBUX has fallen by 61.82% over the past year.  At it's current price of around $8.50, it is trading at only It is currently trading at only 9 times analysts' estimated earnings for 2009 of $0.94.  That's pretty cheap, especially compared to the historic multiple that Mr. Market has awarded this company.  So it's a buy right?  Not in my book.

I personally believe that Starbucks' 2009 earnings will be significantly worse than what analysts' expect.  The company has lost a lot of its luster in the eyes of consumers and money for discretionary spending on things like overpriced drinks is going to be even tighter than many expect next year.  As if rapidly falling revenue wasn't bad enough, Starbucks' input costs may begin to soar again in the near future.

I don't know what its hedging strategy is like, but the company has likely benefited from the dramatic drop in the price of coffee beans that has happened over the past several months.  Arabica coffee recently settled at around $1.16/pound, down from a high of $1.72 in February.  If a commodities market in which everything is falling, regardless of fundamentals eventually stabilizes over the next several months, the price of coffee beans is poised to rise.

Many analysts believe that the dramatic fall in the price of coffee, combined with a tight credit market and high input costs will cause coffee growers to cut back on their use of fertilizer and hurt crop yields next year.  The farther prices fall now, the higher they will likely rise next year as producers have little incentive to invest in producing more coffee. 

Coffee supplies are already tight and they may be about to get tighter.  The International Coffee Organization estimates that the 2008-2009 ending coffee stocks at 17.2 million bags (13% of annual use), which is a historically low level.  This compares with a supply of 25.4 million bags at the end of the 2007-2008 period.  If the coffee crop is disappointing next year, prices are poised to soar.

I see things playing out one of two ways for Starbucks.

1) Either the economy continues to be a disaster throughout 2009, which would probably keep the prices of commodities low, but would be terrible for its business because consumers would cut way back.

or

2) The economy begins to recover at some point in 2009 and coffee prices explode to the upside.

Neither outcome is particularly good for Starbucks.  I strongly believe that analysts' earnings estimates for the company in 2009 are too high.

Deej

No position in SBUX

6 Comments – Post Your Own

#1) On December 03, 2008 at 2:09 PM, devoish (96.00) wrote:

Many analysts believe that the dramatic fall in the price of coffee, combined with a tight credit market and high input costs will cause coffee growers to cut back on their use of fertilizer and hurt crop yields next year.  The farther prices fall now, the higher they will likely rise next year as producers have little incentive to invest in producing more coffee.

The farther prices fall now, the higher they will likely rise next year as producers have little incentive to invest in producing more coffee.

?!???!?

Right now, before it is too late, get some lenders from Citibank down there to tell these idiot growers that the coming coffee shortage has created the perfect opportunity to leverage up and increase production. Now is the perfect time to take on additional debt and increase production. And tell them they have to move quickly before their competitors buy all the fertilizer up and price them out of the market.

Don't those idiot coffee growers have experts to guide them?

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#2) On December 03, 2008 at 2:17 PM, barich1 (40.29) wrote:

Starbucks is so huge now that it has lost a lot of its trendiness.  The "cool people" don't want to be associated with this massive corporation any more... even if they substitute for another company like Pete's, its still cooler.  A lot of people even think of it as an evil empire.  And yes, cutting expensive coffee out of a decreasing budget will be an obvious one for people getting pinched.

   I don't know the industry at all but it seems like the profit ratio on a pound of coffee is so outrageous that they can absorb increased cost pretty well.  How much of a pound does it take to produce a $2-5 cup of coffee?

Logically I agree that the business should suffer.  However I would not risk real cash on shorting it.  It's just such a powerful brand.

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#3) On December 03, 2008 at 2:22 PM, XMFSinchiruna (27.06) wrote:

Starbucks is the world's scariest stock ... as confirmed by Fools.

http://www.fool.com/investing/general/2008/10/31/worlds-scariest-stock-starbucks.aspx

:)

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#4) On December 03, 2008 at 3:00 PM, DemonDoug (32.84) wrote:

am I living in the same world as you guys?  I know people that are coffee afficionados that do starbucks.  Some of them love it, but most of them know they are guaranteed a certain quality.  Also, the basic coffee at starbucks really isn't that much more expensive than McD's or dunkin donuts.

Yes, starbucks will go through a contraction, but deej, your points, they would be valid in a growing or declining economy.

The bottom line is that starbucks has done well, built a solid brand, and has a reputation for quality.  Yes, some might scoff at that premise, but this is from the coffee drinkers I know (and I know a lot of them).

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#5) On December 03, 2008 at 5:57 PM, madcowmonkey (< 20) wrote:

Isn't SBUX a Hidden Gem Pick since the $19 range? It is also in the scariest stock category? How does MF promote these letters they send out for $ and still have people that work for them back on the selections in the blog? I hope these comments sink into the top chefs at motley fool, because this pick has bothered me for sometime now. I think there is a serious issue that TMF needs to work out with the letters they send out and the blogging community. Personally, I laughed at the SBUX call back then and I still laugh at it now, but unfortunately a friend got a hold of the letter and lost on that call. Granted, there isn't much that has done well in the last few months, but to give SBUX as a opportunity to make money during these times is hillarious.

I wouldn't mind seeing a little more communication between the letters you guys send out and your blogging community. I have stayed away from giving the site grief on this, but this is just too much of a smack in the face. TMF will never sell a Stock Advisor letter (what ever you want to call it) with these issues to the madcowmonkey's of the world. Not sure how many are out there, but I am sure some of the other Fools can see the issues with this. 

Deej, you always provide a great blog and I thank you for it!

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#6) On December 04, 2008 at 11:39 AM, guiron (26.14) wrote:

Excellent analysis. The people who push for SBUX remind me of the people who say (or said) that GM is a bargain because people need cars. Yeah, they need coffee, too, but a business model built on a different economy might not work now. 

Starbucks will survive on brand alone. It will not be nearly as big, however. In the future, it will mainly exist around white collar offices and upscale neighborhoods, rather than on every streetcorner. If I were in charge, I'd start offering loyalty incentives and dropping the price of regular coffee, and then advertise the heck out of a good cup of coffee at a reasonable price (and if you want more, just look at the menu). The additional items like music and baubles were good sellers in good times, but I think they have to cut back on that side and work on giveaway trinkets. And look for opportunities in the hospitality side, particularly wherever business travelers go. But I don't think that will pick up for a couple years, if it does.

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