Time for Starbucks?

With Starbucks stock at a 52-week low, is it a good time to buy?
Would you care for a venti, non-fat, sugar-free, one-pump hazlenut, pumpkin spice latte?

These are serious questions that deserve serious answers.

I admit it: I like Starbucks coffee.  I buy the beans and I buy the fresh, hot coffee.  Would I buy the stock?  SBUX is trading for just around $23/share as I write this entry.

Summary/Recommendation

If my portfolio weren’t so heavy into stocks that rely on consumer discretionary spending, I’d consider making a small SBUX purchase today (by small purchase I mean 1/5th to 1/3rd of a total, ultimate position).  Since I’m a concerned about near-term financial results of consumer discretionary companies, the 1/5th number sounds attractive to me. 

(FYI there are many reasons why I buy / sell stocks in increments, or portions of a position.  It's taken some time, but I’ve come to terms with that I won’t be able to call an absolute bottom.  If the stock goes up, I’m happy because I made money.  If it goes down with no changes as to why I bought in the first place, I take advantage of the bargain and buy more.)

Growth Stock?

I think that SBUX, as of several years ago, was a premier growth stock.  Despite that SBUX continues to increase earnings annually, I think it no longer falls into the category of a premier growth stock.  When growth stocks’ growth slows, as legendary investor Benjamin Graham explains, it’s almost a sure thing that there will be P/E multiple contraction.  Keeping in mind P/E contraction is helpful when analyzing SBUX stock price behavior over the last several years.

Over the past several years, the P/E for SBUX has consistently dropped from nearly 70 down to around 28 where it's trading today.

When SBUX growth was higher, the stock tended to trade toward the higher end of that P/E range; however, as growth slowed the stock experienced P/E contraction and moved toward the lower end (note: although we see volatility and variation throughout the year, I’m alluding to an overall pattern).  By analyzing past income statements we can observe that the year-over-year % change for Annual Operating EPS from 2004-2007 went from 42% (2004) to 28% (2005) to 20% (2006) to 15% (2007).  The general rule is that when a growth stock's rate of earnings increase decreases, we often see P/E contraction.

It seems to me that SBUX is trending toward a value play.  Given that's the case, how low the stock goes depends on a lot of things (SBUX ability to deliver, general Wall Street sentiment, etc.).

Shareholder Value

A question worth asking is “Is SBUX management actively increasing shareholder value?”  In this case it seems that they’re making an attempt.  According to the latest 10-Q (for 3Q2007), SBUX has bought back 20 million shares for a cost of $671 million in 2007.  26 million shares remained available for repurchase under current authorizations.  Reducing the number of outstanding shares is a good thing for shareholders.  Keep in mind, though, the benefit is partially offset by the number of shares that may be added to the pool thanks to outstanding options that are exercisable: 45 million with a weighted average exercise price per share of $13.60 (vs. the recent trading price of $23/share).  Overall, the folks who control big money probably already factor in the potential dilution thanks to options when determining a fair value for this stock, so – depending on how the buy-backs are funded* – the buy-backs are a good thing because it means that over all there will be less net dilution.  Less supply makes each share more valuable.

*Some analysts frown upon buy-backs that are funded by debt (instead of cash).  In SBUX case the buy-backs seem to be funded by a combination of debt and cash, depending on how you look at it.  What I can say for sure is that SBUX has delivered historically uncharacteristic negative cash flows for the last 3 quarters (according to their statements of cash flows).  In the last 4 quarters their net income totaled $631 million; their buy-backs totaled $994 million.  Something to consider…

The Industry

When deciding whether to purchase SBUX stock, it also makes sense to consider what’s going on in the industry. Restaurants have been paying increased commodity prices (like dairy).  I think it's no coincidence that as commodity prices have gone up, and SBUX responded by recently raising in-store coffee prices across the board. 

Some analysts are concerned about slowing of consumer discretionary spending, or worse a recession.  These concerns probably increase the risk of pouring big money into the food/beverage industry.  My take is it's not that they wouldn’t put any money in, but maybe that they wouldn’t put in as much as if conditions were considered to be more favorable.

Conclusion

I think SBUX is a good company and their stock is getting cheaper.  In my estimation SBUX will continue to grow and earn more money each year in the years to come.  With no dividend, I imagine SBUX management will continue to increase shareholder value by buying back stock.  At some point Wall Street will decide that the prospects are good once again, which will be reflected in the stock price.  I can’t pinpoint when that reversal (if you want to call it that) is going to take place, so buying a small position now might make sense.

One venti, non-fat, sugar-free, one-pump hazlenut, pumpkin spice latte coming right up!

Full disclosure:  I do not own any positions in SBUX stock at the time of writing.