Invest Skeptically

According to Wikipedia, “in Greek mythology, the Sirens were sea nymphs who lured sailors to disaster with their enchanting singing.” Now they just hang out naked on cups of Venti nonfat half-caff soy lattes.

Starbucks presented their 2008 Q1 earnings tonight. Revenue was up 17.5% to $2,767.6 million and earnings were up 1.5% to $208.1 million. After share buybacks, EPS was up 7.7% to $0.28.

There are many views on what Starbucks is or isn’t (one contributor to the Seeking Alpha blog thinks it’s a restaurant/real estate play) and what the stock, SBUX, should be worth. The discussion board on Google Finance contains many lively debates about this company and the stock.

You can probably guess my own opinion from the title of this blog but I thought I’d focus today on the words that Chairman and CEO Howard Schultz wrote in a Letter to Partners released today in the “press room” section of the Starbucks website.

This fiscal year, we will also open an additional 75 net new stores in international markets, increasing the international store opening target to approximately 975 stores. In 2009 that will rise to over 1,000 stores internationally, and mark the first time that our International store openings will outpace those in the U.S.

Everyone talks about the international opportunity but they are still a long way from getting there. Non-U.S. store sales are still only about 25% of U.S. sales and their operating margins last quarter were 10% versus 14.6% for the U.S. stores. However, even after dropping 44% over the last year, SBUX still trades at around a 22 P/E ratio. Justified?

In the coming months, you will see a renewed level of commitment to providing superior training for our retail partners. We will invest in tools and provide them with the resources they need to exceed customer expectations.

Just who are these tools that they’re investing in? The they in that sentence seems to refer to their retail partners. A Freudian slip or sentence malfunction perhaps?

We will utilize our 35-plus years of ethically sourcing, buying and roasting the finest coffee in the world to reaffirm our coffee authority.

My impression has been–through reading opinions on the web and interviews in Taylor Clark’s book–that coffee snobs have rejected Starbucks as a destination for quality coffee. There’s nothing surprising here. It’s hard to ensure a fresh and consistent product when you have so many stores to distribute to in so many places.

On another note, we have received a lot of attention in the last week about the $1 brewed coffee 8 ounce short test [...] I’d like to reiterate that Starbucks is built on premium coffee and a premium experience. We intend to maintain our leadership position at the high end, while broadening our appeal. And similar to other leading global consumer brands, we believe there are opportunities to create segmentation, provide an entry point for new customers, and generate trial in a way that will also maintain the value of our core brand proposition.

If I were an an investor in SBUX, this is what would really scare me. When Starbucks had the attention of the world and seemed capable of opening stores forever (and filling them with lineups no less) they were doing it without advertising and without discounting. Now I see print ads fairly regularly and this $1, free refill, coffee is basically a discounting program.

If Starbucks is selling a “premium experience”, I don’t see how they can broaden their appeal “similar to other leading global consumer brands”. You can segment and sell different kinds of shampoo but there’s only one kind of Porsche–the expensive kind. Thus, if the “Starbucks Experience” is just a consumer product, like shampoo, then what’s the upside for the stock at these levels?