Over the past five days, three firms have cut their ratings on Starbucks; two have gone from buy to hold and one from hold to sell. All of the downgrades cited basically the same reasons; the company is going to report a lousy quarter and the McDonald's marketing machine is going to make it nearly impossible for Starbucks to survive. This is now consensus!
What if things are not that bad? - We know from the trends in most of the consumer discretionary universe that things are "less bad" in 1Q08.
What if the hundreds of store closures have had a positive impact on sales trends? - 75% of the stores closed are within three miles of an existing company-operated store.
What if lower commodity prices and reduced labor expenses help to stabilize margins? - Milk prices are down about 35% year-over-year.
What if our grass roots survey is right and sales trends improved during the quarter?
What if McDonald's gourmet coffee strategy does not work?
Don't get me wrong, the issues Starbucks faces are far from trivial and McDonald's is a great competitor, but to think that Starbucks is not fixable is crazy. There are a lot of high-end retailers that are not doing well today. The Starbucks basic drip coffee is anything but expensive at around $1.65 for a 12oz cup.
It has been well over a year since Starbucks first announced its initial restructuring, including slowed U.S. unit growth, store closures and a renewed focus on store-level unit economics. Although these transformational changes all signaled a move in the right direction for the company, Starbucks' stock is still down nearly 40% in the last year as sales trends deteriorated further. The company has since announced $500 million in costs savings in FY09 alone, which should help to offset sales weakness. SBUX's fiscal 1Q09 results reflected these cost saving initiatives as EBIT margins improved sequentially from 4Q08 even with U.S. same-store sales declining 10% (worse than the 8% decline in 4Q08). And, the savings are expected to accelerate throughout the year. The stock's 21% move year-to-date reflects these improved results.
In order to sustain continued stock price appreciation, SBUX cannot rely on cost saving initiatives alone. Investors will expect to see a turnaround in sales to keep bidding up SBUX's stock price. That being said, I set out to come up with a way to gauge SBUX's progress toward improving monthly sales trends, which resulted in the inception of the SBUX monthly "grass roots survey." With Starbucks introducing its combo meals in March (the company's first attempt at a nationally promoted price point and a significant change in management strategy), I thought March would be a telling month to get started. To that end, of the stores surveyed (representing a geographic mix across the U.S.), they are selling an average of 20 of these breakfast combo meals per day.
STARBUCKS MARCH "GRASS ROOTS SURVEY" SALES TRENDS:
The survey indicates that March same-store sales on average were flat to -3%. These numbers are so good I don't believe what I'm seeing. Naturally, I provided a haircut to the numbers, but that would still put SBUX same-store sales at down 5-7%. This would be a significant improvement from the trends in fiscal 1Q09 when same-store sales declined 10%. As this is the first month of the survey, I think it is more important to focus on the numbers on a directional basis rather than looking at the absolute numbers, and directionally, these March numbers look better than what we have been seeing out of Starbucks' U.S. business.
Also of significance was that 100% of the partners surveyed commented that they thought management was taking the company in the right direction, with its new focus on combo meals and value offerings being the most consistent supporting answer, particularly in light of today's challenging economic environment and its subsequent toll on consumers. A handful of Starbucks partners pointed out that advertising would help even more, which according to CEO Howard Schultz should be coming soon as he stated at the company's March annual meeting that the company is ready to take its gloves off and will no longer be silent regarding the false claims its competitors have made about the Starbucks brand in the past. As I said earlier today in my post titled "BKC - What's up with Burger King...?", advertising is critical to driving incremental traffic within the mature QSR segment. Time will tell!