Starbucks surprises by five cents in Q3, thanks to focus on the basics

While investors and analysts have been highly critical of Starbucks (SBUX) over the past 24 months, sending the stock tumbling to a several-year low, the past few months have been quietly blissful. The stock is up more than 87 percent, to $14.69 at today's close, since November 21, when SBUX hit its longtime low of $7.06. Turns out November would have been a great time to buy.

After the bell today, Starbucks announced mildly stunning results. Analysts' consensus had been earnings of 19 cents a share; after onetime charges, Starbucks's non-GAAP earnings came in at 24 cents a share, or $151.5 million, compared to 16 cents a share in Q3 2008, on revenue of $2.4 billion, compared to $2.6 billion in Q3 2008 and $2.3 billion in Q2 of this year. Comparable store sales were down five percent between Q3 2008 and 2009, which Starbucks says was an improvement over Q2 2009, with a nine percent same-store sales decline. The stock was up to $15.25 in after-hours trading as investors cheered this surprise.
Why the company picked this morning to offer free pastries to customers who showed a coupon at the cash register can only be speculated, but I was among the many analysts who visited a local Starbucks today in preparation for this afternoon's earnings. Greeting me were a tray full of pastries at the ready for eager customers; friendly, peppy staff; and a raft of promotional material advertising the company's new campaign -- "Real Food. Simply Delicious," which I opined last month was an attempt to jump on the Michael Pollan bandwagon. The buzz was at least vivid in this day of impending celebration. We could only wonder: Was Starbucks preparing for a financial party?

There were many challenges. Consumers were cutting back, and many were choosing to eat more local, seasonal, less processed, less sugary food after coming face-to-face with the reality of their choices in Food, Inc. and Pollan's considerable media appearances.

More insidiously, McDonald's was facing off against the chain with its wide rollout of McCafé offerings and its cheaper prices for regular coffee and breakfast sandwiches. There was even an undercurrent of corporate dissatisfaction with the chain due to the many laid-off employees and favorite stores shuttered.

Starbucks overcame all that. When it comes down to it, McDonald's McCafé products were ill-prepared, overpriced, and over-sweetened. (An iced lattè I bought in an Oregon highway-off-ramp outlet of the fast-food chain this weekend was so bitter I winced when I took my first sip, and it was more expensive than the same drink at Starbucks.) At the very end of the quarter, Starbucks rolled out treats without artificial preservatives, flavors or colors, and started to use more seasonal ingredients like "Oregon blueberries" and "Michigan cherries." Connecting the consumer to the source of the food is, after all, the thing to do this year.

The impact of the new, less processed, more "natural" treats, which in my opinion taste identical to the previous iteration and are just as sweet, is yet to be felt in the income statements. But the buzz is going, and it's hard to argue with cost savings, even if they come at the expense of small pockets of community goodwill. The expansion plans of the early part of the decade were untenable; scaling back was a sensible choice.

Hundreds of millions in shareholder value, though, were undoubtedly lost in the missteps, and investors are nothing if not eager to forgive and forget. The past two years have seen some $400 million in charges, and the stock may never again see the high $30s of 2006. Will the company recover?

Many see hope in the new experimental un-branded venture, meant to capitalize on the way today's consumer is shedding brand loyalty in search of authenticity. Much though it pains me to say so -- its very inauthenticity is writ bold on even the most superficial analysis of the experiment -- I think it's the right way to go. Management's caution (or lack thereof) will be the thing to watch here. Unhinged charging into costly projects has been proved to be a bad idea. Focus and careful attention to consumer desires is what gives us this surprise.

Whether future results will be pleasantly expected or a nasty surprise will depend on the continued focus of Starbucks management. We've seen what one quarter can do. Many more quarters are required.

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