Loneliness as the bottom approaches for Starbucks

Posted by: Aaron Pressman on April 24, 2008

Lots of moaning today about Starbucks (Symbol: SBUX) and how the company’s business model is broken or forever condemned to stink or whatever. So much pessimism, so little time. Pop quiz: here’s a write-up about a company announcing weak results with the name and date removed. Can you name the company?

NEW YORK (CNN/Money) - XYZ Corp. slashed its fourth-quarter guidance Tuesday, saying it expects to post its first-ever quarterly loss after taking a multi-million dollar charge to pay for job cuts. It also plans to close underperforming restaurants. Shares of XYZ, the most actively traded stock on the New York Stock Exchange, fell $1.39, or 8 percent, to $15.99, widening its year-to-date losses to 39 percent. More than 35 million shares changed hands.
Trying to save money, XYZ said it will take a $435 million charge to close underperforming restaurants and cut jobs, forcing XYZ to lose 5 to 6 cents a share in the fourth quarter ending this month. XYZ and other [companies in the same subsector] have become entangled in a price war in recent weeks, trying to outdo one another with dollar-menu items, which at least in XYZ’s case, has had a minimal impact on sales and has cut into margins. Peter Oakes, who covers XYZ for Merrill Lynch, downgraded the stock and cut his price target to $25 a share while lowering his profit forecasts on the company. “The news was not encouraging,” he told clients.

Who could it be? Not too hard — McDonald’s (MCD) back in December 2002 at the tail end of one of the fast food giant’s worst years in recent memory. And guess what else? That wasn’t the worst of it for the stock, which sank as low as $12 within a few months. As the bottom approached, talking heads and pundits everywhere declared McDonald’s business model expired, complaining that the company had opened too many outlets. They pointed to increased competition and McDonald’s lack of focus on what its customers really wanted on the menu. Sound familiar?

Now, sure, McDonald’s is a unique company and just like most promising tech start-ups won’t turn out to be the next Microsoft (am I dating myself? Should I say won’t turn out to be the next Google?), few restaurant chains will end up as successful as the Golden Arches. But I think the parallels to Starbucks are pretty compelling.

Both chains built a tremendously well-known and valuable brand in growing but competitive sectors of the food business. Both got stale and made missteps trying to expand and “improve” their menu of offerings to bring in more revenue. Both lost confidence with investors and saw their valuation multiples shrink. And both took a hard look at what needed to be fixed and got to fixing it. And, importantly, neither is selling a gimmicky product like hot donuts and neither is in a dying industry like newspapers or camera film. It’s never pretty at the bottom, especially when the economy is going soft, but that’s what makes value investing so tough.

Reader Comments

argentish

April 24, 2008 5:55 PM

MCD was down about 70% from its all-time high when it bottomed out in 2003. If Mr. Pressman's MCD/SBUX comparison is right, SBUX should bottom out at around $10 before starting to rise again.

Seattleite

April 25, 2008 11:05 AM

"neither is selling a gimmicky product"... A 4-5$ cup of coffee is considered a necessity now?

Jefferson

April 27, 2008 7:58 PM

Of course, the difference is that it took McDonald's more than 50 years to hit rock bottom.And McDonald's, which is on the rise as you noted, is going after the non-pretentious coffee drinkers that SBUX is seeking.

Terry

April 27, 2008 11:35 PM

$4 coffee is indeed not a necessity.

However, Starbucks does not offer coffee.
It offers an experience.
It offers a place to social.
Starbucks charges for that.
That is Starbucks' strategy. It's not about selling coffee. Anyone who actually studied the company will know that.

"Social" is a basic human necessity and it won't go away. Perhaps during a recession people will come out less but don't count on it being a long term trend.

Nicholaus

April 28, 2008 1:59 PM

*yawns* "A 4-5$ cup of coffee is considered a necessity now?"

Exaggerate much?

In the NY market, and the Northern California market for sure, the largest sized coffee comes out to under $2.15 depending on taxes.

If you want a specialty crafted drink, yes it will be more but that's just common sense.

Your "witty" comment just comes off as tired and sad.

Lou Sussler

April 28, 2008 2:33 PM

No, a $4.00 cup of coffee is not a necessity but neither is that what Starbucks sells.

You certainly can pay $4.00 and up for a drink at Starbucks but if you walk in and get a cup of coffee, it costs exactly the same (plus or minus a nickel) as the Dunkin Donuts or Independent coffee shop down the block.

jefferson

April 28, 2008 11:31 PM

Are customers buying the coffee or the $4 specialty drinks?

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Bloomberg Businessweek’s Ben Steverman focuses on the latest moves in financial markets and emerging trends in stocks, bonds, and funds, always with an eye toward giving readers a better understanding of the sometimes confusing and often chaotic world of money. Standard & Poor’s senior index analyst Howard Silverblatt will also provide his take on companies’ finances and the markets. Voted one of the “Top 100 Finance Blogs” in 2007.

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