Starbucks: Serving a Venti Cup of Desperation

by Jeff Reeves | June 7, 2012 6:00 am

Starbucks: Serving a Venti Cup of Desperation

Starbucks (NASDAQ:SBUX[1]) is one of the biggest comeback stories since the financial crisis. After bottoming out just north of $8 a share in spring 2009, shares of SBUX stock are now up over 530% to over $53. That’s right in step with growth darling Apple (NASDAQ:AAPL[2]), and over seven times better than the Dow Jones Industrial Average.

But if you ask me, this stock is about to melt into a soupy mess faster than a Frappuccino in the Florida sun.

sbux 300x210 Starbucks: Serving a Venti Cup of Desperation
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Looking at the facts behind this stock right now, there are a lot of reasons to be skeptical:

These are all bad signs. But my biggest reason to be bearish on Starbucks isn’t any of this; it’s recent moves that show a lack of strategy and a lack of focus, highlighted by head-scratching acquisitions and downright absurd product launches.

Take a look:

Dumb Starbucks Move #1: Vending Machines

I am not making this up. Starbucks just inked a deal with Coinstar (NASDAQ:CSTR[5]), the company behind RedBox DVD kiosks and those coin-collecting gadgets at grocery stores, to serve up coffee at big box retailers, drug stores and grocers nationwide.

The five-year deal will kick off with 500 machines installed by the end of 2012, boasting the lower-priced Seattle’s Best brand from the SBUX portfolio of products. The java will start at $1 a cup.

Um, hello? There is already a Starbucks in my Safeway (NYSE:SWY[6]), my Target (NYSE:TGT[7]) and even one in the strip mall between my Safeway and Target. Besides, anyone who has ever worked in a joyless office with a clunky coin-op coffee maker in the cafeteria has rather unpleasant memories of the java that is spewed out of a vending machine. Getting consumers to take that leap involves overcoming some serious preconceived notions about vending machines. (Read more about the absurd vending machine deal here[8].)

Dumb Starbucks Move #2: Bakery Buyout

Starbucks just made waves by buying the San Francisco’s Bay Bread bakery[9] for $100 million. And stock rightly sold off immediately afterwards as a result.

Apologies to my colleague Will Ashworth, who is bullish on the deal[10], but this is just plain silly. For instance, wrap your head around this quote by CEO Howard Schultz in a press release[11]:

“This is an investment in our core business. After more than 40 years, we will be able to say that we are bakers too.”

In what alternate universe does your core business involve something you haven’t done in the 40 year history of your company?

The squints at Starbucks are clearly looking at numbers but not reality. Yes, about $1.5 billion or 10% of SBUX revenue comes from food. Yes, food sales have seen double-digit increases the last two years. There is admittedly more upside here, too.

But Starbucks execs are deluding themselves if they think they can easily become a Dunkin’ Donuts (NASDAQ:DNKN[12]) where the food is as big a driver of traffic as drinks. And SBUX is also foolish to think that the move by McDonald’s (NYSE:MCD[13]) and other restaurants into premium beverages is a two-way street, where a drinks giant can easily stake out a claim on the lunch crowd the same way McCafé snapped up folks looking for a caffeine fix.

Dumb Starbucks Move #3: Verismo

All investors should know about the disaster of Green Mountain Coffee Roasters (NASDAQ:GMCR[14]) now that its single-serve Keurig coffee maker is going off patent and the market has reached its saturation point. GMCR stock has flopped from $110 a share last fall to under $25 currently. That’s a nearly 80% decline.

But if this company melted down as its iconic Keurig lost momentum, why is that a sign that the market needs more coffee gadgets this late in the game? Somehow Starbucks thinks its own single-serve machine, with the silly name Verismo[15], will be a success anyway.

Maybe there is still decent business in the appliance market. But don’t forget Green Mountain made most of its cash on licensing the K-Cup pods for the Keurig, not on the machines it sold for meager margins.

And SBUX was already peddling its own branded coffees for the Keurig and other single serve machines, so it already had a hand in this market!

Bigger margins indeed come from cutting out the middle man. But that doesn’t mean it always makes sense. For instance, Starbucks doesn’t own its own ice cream facility and instead allows packaged foods giant Unilever (NYSE:UL[16]) to produce its Java Chip Frappuccino flavor for a cut of the profits.

Though after the Bay Bread deal, I guess I shouldn’t give them any ideas …

The bottom line is that this is a low-growth move at best, and appliances are way outside the SBUX comfort zone.

Biggest Dumb Move of All: A Lack of Focus

Last November, Starbucks bought the Evolution Fresh juice brand to bolster its bottled drink offerings in-store, and then rolled out its first Starbucks-owned juice bar in March[17].

Now we’re talking! This is actually something that is very aligned with the core business of quality drinks served up with a smile at Starbucks cafés …

Except that with all this other crap going on, you have to wonder if this jaunt into the juice biz will go off the rails too. After all, this hardly all adds up to a comprehensive strategy.

The biggest irony of Starbucks right now is that its stunning resurgence since 2009 lows has was due to cutting out the clutter. SBUX stopped selling so much crap at the counters, gave up on its asinine record label[18], and reemphasized the great café experience that made it so successful.

And now that SBUX is back on top, company leaders are forgetting how they got there.

When Howard Schultz took over again as CEO in 2008 after an eight-year hiatus, he closed underperforming stores that had popped up due to over expansion, and vowed to return Starbucks’ attention to its customers and rejuvenating its dominant brand.

Now we get juice that doesn’t even bear the Starbucks logo?

Now we get baked goods as the “core business” of SBUX?

Now we get coffee kiosks where we have to serve ourselves? And if we buy we get the Seattle’s Best “off brand?”

I won’t argue with Starbucks performance since its reinvention under Schultz.  SBUX has posted year-over-year revenue growth and earnings growth in every period dating back to Q4 2009, making a streak of 10 consecutive quarters where profits and sales have both moved up.

But be wary of expecting that kind of momentum to continue forever.

Remember, SBUX stock crashed from a high of around $45 in 2006 to a low of around $8 during the depths of the economic meltdown in 2009. In case you’re bad at math, that’s a gut-wrenching 82% decline.

The reasons for the shock? A failure in corporate leadership and vision that coincided with an economic downturn that gutted consumer spending.

If you’re an Starbucks investor, take a look around. Things are very different in 2012, but in many ways the risks are the same as they were five years ago.

Jeff Reeves is the editor of InvestorPlace.com and the author of “The Frugal Investor’s Guide to Finding Great Stocks.”[19] Write him at editor@investorplace??.com or follow him on Twitter via @JeffReevesIP. As of this writing, Jeff Reeves did not own a position in any of the stocks named here.

Endnotes:
  1. SBUX: http://studio-5.financialcontent.com/investplace/quote?Symbol=SBUX
  2. AAPL: http://studio-5.financialcontent.com/investplace/quote?Symbol=AAPL
  3. margins were slipping: http://www.forbes.com/sites/afontevecchia/2012/01/26/starbucks-highest-revenues-ever-but-margins-taking-a-hit/
  4. disappointing same-store sales: http://blogs.barrons.com/stockstowatchtoday/2012/04/26/starbucks-beats-expectations-shares-falling/
  5. CSTR: http://studio-5.financialcontent.com/investplace/quote?Symbol=CSTR
  6. SWY: http://markets.financialcontent.com/investplace/quote/detailedquote?Symbol=321%3A968165
  7. TGT: http://markets.financialcontent.com/investplace./quote?Symbol=TGT
  8. Read more about the absurd vending machine deal here: http://investorplace.com/2012/06/coinstar-to-launch-starbucks-seattles-best-coffee-kiosks/
  9. buying the San Francisco’s Bay Bread bakery: http://investorplace.com/2012/06/starbucks-buys-bakery-chain-for-100m/
  10. Will Ashworth, who is bullish on the deal: http://investorplace.com/2012/06/starbucks-bakes-a-brilliant-move/
  11. press release: http://news.starbucks.com/article_display.cfm?article_id=661
  12. DNKN: http://markets.financialcontent.com/investplace/quote/detailedquote?Symbol=537%3A12977435
  13. MCD: http://markets.financialcontent.com/investplace/quote/detailedquote?Symbol=321%3A950605
  14. GMCR: http://studio-5.financialcontent.com/investplace/quote?Symbol=GMCR
  15. with the silly name Verismo: http://investorplace.com/2012/03/starbucks-single-serve-coffee-may-kill-green-mountain-sbux-gmcr-keurig-verismo/
  16. UL: http://studio-5.financialcontent.com/investplace/quote?Symbol=UL
  17. Starbucks-owned juice bar in March: http://investorplace.com/2012/03/starbucks-schultz-is-still-dreaming-big/
  18. gave up on its asinine record label: http://news.starbucks.com/article_display.cfm?article_id=48
  19. “The Frugal Investor’s Guide to Finding Great Stocks.”: http://www.amazon.com/dp/B007KB9CSI/ref=rdr_kindle_ext_tmb

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