Starbucks -Don’t Be Fooled Again: Stong Brand Does Not Equal Strong Stock

We went on record that investors should short SBUX on 11/6/2006 when the stock was close to $38 per share. Click here to see the Fortune Article. The stock did not look attractive to us until 2 years later when it was under $8, and that for only about 3 days (11/18 – 11/20/08). Ever since we have had a Neutral or Dangerous Rating on the stock.

Don’t get me wrong, Starbucks has performed a rather remarkable turnaround in profits as it switched from an aggressive growth strategy to a retrenchment strategy as we suggested they should do on CNBC on 11/16/2006. Click here for the interview. And I believe the change in logo is a smart move as it emphasizes Starbucks intelligent shift from focusing on selling a commodity (e.g. coffee and the like) to selling a brand, which offers higher margins. But that shift has already largely take place. There is not that more room to grow before larger, more established players in the consumer packaged food space take notice. And those companies with comparable brand power and superior distribution put a cap on Starbucks growth opportunities.

The bottomline: Starbucks is a good company but not a good stock. There is simply not that much profit opportunity in a coffee shop no matter how glamorous they make the coffee-drinking experience.

The valuation is already rich and expectations are high. In other words, the market and investors have already set a very high bar for future performance. Specifically, the current stock price ($32.35) implies the company will grow profits at a 10% Compounded annual growth rate (CAGR) for 15 years. In addition, the company is not as profitable as people think as it carries about $3.6bn in off balance sheet debt – equal to about 80% of the company’s reported net assets.

All the details are in our Company Valuation Report on SBUX. Available for free here.

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