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Starbucks: A Buy At What Price?


By Todd Sullivan
24/7 Wall St
May 17, 2007

There have been a slew of articles the past week about the price of Starbucks (SBUX) shares and whether or not now is the time to buy them. Let's look closer. Currently Starbucks shares trade at $28 for a PE ratio of 31 times this years 89 cents a share earnings estimate. Many people consider this a bargain saying "Starbucks shares have not traded at this level since Oct. 2005." But is Starbucks situation now the same as then?

In a word, no. [emphasis in the original] If they hit their EPS growth goal, Starbucks will grow earning this years 18% vs the 30% they grew them in 2005 and as each day goes by, that "if" becomes larger and larger. A closer look at last quarters earning shed some light on upcoming difficulties. Earning were met chiefly due to an unusually large $500 million share buyback and enabled Starbucks to gloss over the fact that margins continue to deteriorate. This buyback become larger when you consider in all of 2006 only $695 million worth of shares were repurchased.

What has not been discussed is the dairy and coffee situation. Both are going to experience an explosion in prices this year and Starbucks did disclose in the recent earnings call that they are not able to "substantially" hedge against these increases because a buyer for the hedge on the other side is not available. Translation?

Everyone knows these prices are going up these, so other than additional prices increases to their customers, Starbucks has no way of avoiding these cost increases going directly to the bottom line. Add the fact that they only served 1% more people, you now have a recipe for accelerating margin decreases.

This will increase the already deteriorating margin picture and may now begin to effect growth plans. When margins continue to decline, in order for Starbucks to retain it's over ambitious growth plans, it will need to rely increasingly on debt. Note that in the recent quarter $488 million net in debt was issued which was more than twice the sum total of the past 6 years.

So what price then? Shares have to fall substantially from here before anyone should consider them. Starbucks has traditionally sold at a slight premium PE (1.25 to 1.5 times) to it's growth rate. With that rate at this year at MAYBE 18%, its current 31 PE is grossly over valued. A price range of $22 to $27 put us in a historic PE to Earnings Growth range. Now, that also assumes they hit the 18% EPS growth which I am doubting more and more as each day passes.

With all the uncertainty surrounding the company at this point, I could not even begin to consider shares at any price other than the lowest end of the range, $22 or another 21% lower than currently.

Disclaimer: I have no nor have I ever had any position in Starbucks. Todd Sullivan
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