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    MARKET EDGES

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I can almost guarantee that Howard Schultz did not want to report a loss this quarter – the press would have skewered him. I know that seems stupid but I can actually see him thinking that way. I know this has nothing to do with an analysis of the SBUX quarter, but what more can be said about this quarter that has not already been said. I continue to think that SBUX is one of the companies that we want to own coming out of the cycle we are in, but trying to pick the bottom of the cycle is proving treacherous.

The case for SBUX is clear; (1) A global brand, selling a habitual product, operating in multiple distribution channels, (2) $1.0+ billion in operating cash flow, and (3) a strong balance sheet.

The case against the company is also clear; (1) consumer demand for premium coffee, (2) excessive growth of the past may have hurt the brand, and (3) a new, extremely powerful competitor.

  • So it has boiled down to trying to pick the bottom and when things will become “less bad” for the company. When things stop getting worse it can get better. Right now it looks like fiscal 2Q09 will be that quarter. When the company was focused on non-stop growth it tried to broaden the appeal of the concept. Today that strategy is costing the company dearly. In a challenged economic environment there are a number of consumers who just cannot afford SBUX anymore. Starbucks, however, is not going away and at some point the company’s traffic declines will stop. The question is what percent of its customer base will go away before this group of core consumers emerges? 3%, 6%, 9% - who knows! I don’t think its 15%!

    As of fiscal 4Q08, U.S. traffic declined 5%. The company commented that this quarter may represent the bottom in that metric. The way the math works that may be true as it relates to the level of customers coming into the store, but the street’s math looks at YOY comparisons and 1Q09 marks the company’s most difficult comparison for the year so the YOY decline could look worse in 1Q09. From the street’s perspective, the company will most likely not see a YOY improvement in traffic trends until fiscal 2Q09.
  • There is no rush to run out and declare a bottom for SBUX. Management is doing what they need to do to address the issues that plague the company. Having said that, I’m sure there is still a lot of fat to cut from the corporate structure so the company can earn $0.70 or better in FY 2009 (flat YOY), despite the level of same-store sales. That should provide support for the stock in the $8-9 range. If we can prove that the company will only lose 5% of its customer base the next 3-6 months should represent the bottom in the stock.