Recommendation: Use key $52 technical level to provide direction on whether stock will yield to fundamental improvement or succumb to macroeconomic worries. Open long position on a break above $52 with higher than average volume.
Option Alternative: On a break above $52 per share buy to open the April 2013 $52.50 calls for $4.00 per share or less.
For a while Starbucks (NASDAQ:SBUX) was as synonymous with being everywhere as it was with specialty coffee. In 2008, however, Starbucks focused on evolving the brand rather than expanding it. That took the stock from sub-$10 in 2008 to a high this April over $61. 2012 was the first year in which this trend has paused.
Does the continuing evolution strategy give SBUX more room to grow the brand and the stock price? Or are things topping out here for the specialty coffee retailer?
Growth in 2013
For the last four years the company focused its resources on improving the customer experience within stores rather than opening new ones, especially in the US. From 2008-2010 Starbucks cut costs by closing 800 stores in the U.S. and shedding about 19,000 positions. The result? A rejuvenated brand, a reasonable growth strategy, and a focused management team.
Then, in April of this year with the stock near its high, the company issued lower guidance for Q4 2012 and then lowered expectations again in late July. This sapped nearly 29% from the stock’s value in three months. However, when the company announced Q4 results, they beat the reduced expectations, increased their dividend, and increased their outlook for 2013. They also reported that same store sales increased 9%, noteworthy for a mature company. The stock jumped 9% on the news to nearly $51.
SBUX recently purchased Teavana (NYSE:TEA) for $620 million. Despite analysts’ misgivings, that price was only 10.3x TEA’s estimated 2013 EBITDA, below SBUX’s own multiple of 12x and nearly a 10% discount from TEA’s IPO price.
TEA’s shares were under pressure this past year from underperforming expectations and same store sales that slowed from 8-9% last year to 2-4% this year.
50% of TEA’s sales come from loose leaf tea and approximately 40% come from related goods. Only about 5% of sales are derived from on-site beverage sales. So the question now is whether Starbucks can boost revenues and in-store beverage sales.
Single Cup Coffee Race
Back in September, SBUX unveiled its Verismo single cup coffee machine, which could challenge the dominance of Green Mountain Coffee Roasters’ (NASDAQ:GMCR) Keurig machines in the $8 billion at-home single cup coffee industry.
Verismo benefits from SBUX’s premium brand appeal and its competitive pricing. Though SBUX also offers several kinds of coffee for Keurig machines, Verismo will be an important part of SBUX’s channel diversification and moving the brand into homes.
Pricing Power and the Ultimate Cup of Coffee
With their newest premium coffee priced at $7 for a grande, SBUX is testing how much are consumers willing to pay for a cup of coffee. Called the Finca Palmilera, the coffee comes from Costa Rica and derives from the Geisha heritage varietal coffee bean. Its high price is due to its rare supply. In fact, SBUX has only 3,800 lbs of the beans, and is offering the Finca Palmilera in only 48 stores, half of those in Seattle.
SBUX’s ability to successfully sell a $7 medium-sized cup of coffee is an indication of the company’s pricing power. While SBUX may not be able to achieve the 20% top line growth it saw prior to 2007, it has cultivated a moat around its brand that, in the minds of consumers, is still as wide as ever.
When to Buy — and an Options Alternative
Click to EnlargeSBUX’s recent performance brought the stock up against a firm resistance level. After pulling back from its high in April, the $52 level provided support through spring until the company’s second round of reduced guidance plunged the stock well through it. Now that ceiling has proved formidable.
The stock has momentum in its favor and a positive set of internal developments. The slowing domestic economy and the fiscal cliff are strikes against that momentum. Keep an eye on this $52 technical level. It can provide direction on whether the stock will keep gaining ground into 2013. We recommend opening long positions above $52 per share on higher than average volume.
Starbucks has a very liquid option chain sheet – even with the longer expirations. That gives you a cost advantage through a tight bid-ask spread. On a break above $52 with higher than average volume we recommend buying to open the April 2013 $52.50 Calls for $4.00 or less. Consider a short term exit when the stock reaches $56 per share for plenty of upside without too much time-value risk.
John Jagerson and S. Wade Hansen are co-founders of LearningMarkets.com, as well as the co-editors of SlingShot Trader, a trading service designed to help you make options profits by trading the news.