Why Starbucks Will Never Be Great Again

Here's why your Starbucks (SBUX) barista is all smiles these days: The popular hub of latte lovers and Frappuccino sippers is rolling. Despite the tumultuous market that has battered many consumer-facing companies, shares of Starbucks hit an all-time high last week. Over the past three years, an investment in the premium coffeehouse has come through with a return that is seven times the S&P 500's modest gain.

The stores are buzzing again. Analysts see revenue climbing by nearly 9% to $11.6 billion for the fiscal year that ends later this week. Earnings have been growing even faster.

However, in order to appreciate the mug of pessimism that I'm about to pour out, it's probably best to go over where Starbucks has been -- and where it's going.

Mocha Mania

You won't find me knocking Starbucks CEO Howard Schultz once in this rant. He was instrumental in bringing European appreciation for premium brews into this country, making it fashionable to be a java junkie.

My beef about Starbucks is solely with the investors that have bid up the shares to unsustainable levels, especially given the challenges that await Starbucks in the near future.

Has every long-term investor just flat-out forgotten about what happened to this company in 2008? A reminder: Starbucks was crushed by the recession, leaving it with no choice but to initiate morale-thumping layoffs and closing locations. It cut prices. It tweaked menu offerings. It paid the price for saturating the market.

Starbucks bounced back, obviously. However, so did everybody else.

How Would You Like Your McDunkin' Brew?

Premium coffee is no longer a Starbucks away. It seems as if every fast food or quick-service chain with a drive-thru lane is beefing up its coffee, making a decent cup of Joe as convenient as possible.

McDonald's (MCD) has beefed up its McCafe product line of hot beverages. Dunkin' Donuts parent Dunkin' Brands (DNKN) went public this year, more on the strength of its popular brews than its namesake doughnuts. It hit the market to facilitate its aggressive West Coast expansion.

And then there's the 800-pound Keurig gorilla in the room.

K-Cups with the K-O

Green Mountain Coffee Roasters
(GMCR) has made it even easier to provide premium caffeinated boosts throughout the day with its Keurig single-cup brewers and K-Cup refills.

Investors cheered when both companies agreed to team up earlier this year. The deal will begin kicking in during the coming months when Starbucks starts selling its roasted beans in K-Cup form and Keurig machines in its stores. In exchange, Green Mountain is making Starbucks the exclusive "super-premium" provider of K-Cup coffee.

Let's think about that. Imagine walking into a seafood restaurant selling you fishing rods. Imagine walking into a bookstore selling you e-readers. (No offense, Barnes & Noble (BKS).)

Once consumers can make Starbucks coffee at home in mess-free single-cup servings for less than it costs at the neighborhood coffeehouse, will they continue to frequent the suddenly souring barista?

"This will never happen," bulls will counter. Starbucks wouldn't have struck this deal unless it knew that it would be incremental to its business. Perhaps, but it's also just as likely that Starbucks recognized the culture-twisting nature of its eventual disruptor, deciding to play along so it can profit less instead of not profiting at all.

Holes in My Bearish Brew

Keurig doesn't have a solution for the fancier drinks that Starbucks offers. You could also rightfully argue that all of the competition doesn't appear to be slowing performance.

Despite waning consumer confidence and stubborn unemployment rates, the 'Bucks queues are quite grande. Store-level sales popped 8% in its latest quarter, fueled by a 6% spike in traffic and a 2% increase in average ticket per customer. In other words, more coffee cradlers are coming in -- and they're spending more.

Starbucks also has a solution to maxing out the stateside market. Just 8% of its revenue -- and 6% of its operating profit -- stems from its international operations. There are opportunities overseas, especially if it can turn China's tea-sipping culture into coffee drinkers.

Unfortunately, things just aren't that easy.

Green Mountain is growing a lot faster than Starbucks. Comps will take a hit if the economy slows down or if the competition continues to get smarter. As for the international opportunities, while they account for just 6% of this past quarter's operating income, international stores already account for more than a third of the total Starbucks stores out there.
Even after factoring in the different mix of licensed stores over company-owned locations internationally, profitability levels overseas aren't really moving the needle.

This brings us to valuation.

Is Starbucks really worth 22 times forward earnings? This is already a pretty mature company with its greatest growth in the rearview mirror. It is susceptible to the fickle nature of discretionary income.

I'm a fan of Schultz. I recognize that many of my Motley Fool colleagues are diehard bulls here. However, it's hard to picture Starbucks being more popular in three to five years than it is right now.

Longtime Motley Fool contributor Rick Munarriz does not own shares in any stocks in this article. The Motley Fool owns shares of Starbucks. Motley Fool newsletter services have recommended buying shares of Green Mountain Coffee Roasters, Starbucks, and McDonald's, as well as creating a lurking gator position in Green Mountain Coffee Roasters.


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11 Comments

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AmaRican4Life2

Enjoy A Great Cup Of Starbucks & Or K-Cups...Yum!

November 14 2011 at 10:36 PM Report abuse rate up rate down Reply
danifredo

Not the most rational of articles. Remind me not to base investment decisions on anything reporters churn out for their next deadline. Yawn.

October 03 2011 at 8:34 AM Report abuse rate up rate down Reply
Scotty143124

Starbucks is a great American company that actually gives a crap about how it treats people and their employees.

The thought that I would go support places that pay people minimum wage plus 5% to 10%, while their owners, shareholders, and board get filthy rich; well, it is not going to happen.

September 30 2011 at 6:01 PM Report abuse rate up rate down Reply
Cheese

People go to Starbucks not just to have coffee, but primarily to hang out. The argument that K cups will kill Starbucks is akin to saying that DVDs would kill cinema.

September 30 2011 at 4:24 AM Report abuse +1 rate up rate down Reply
maa2626

does anyone else beside me not care for starbucks coffee? It has an acquired taste, like scotch and never seems hot enought.

September 29 2011 at 10:08 PM Report abuse rate up rate down Reply
dabrownman

I love Starbucks coffee that mainly comes from Indonesia where wild cats eat the raw coffee beans and then poop them out and are harvested by people with very unclean hands. It is very expensive coffee indeed. But, it does explain why Starbucks coffee Sp dark and strong !

Can anyone name the cat that does the 'natural' processing for Starbucks?

September 29 2011 at 8:41 PM Report abuse rate up rate down Reply
Greg

The guy that founded McDonalds always reminded people that he was in the real estate business first and foremost, and then secondly he just happened to sell fast food.

There are Starbucks everywhere, and most if not all offer free wifi and a comfortable place to sit and spend a few hours. There's probably millions of people throughout the world who use Starbucks at least once a week as a place to get some work done. I know I do, and often I notice that every sit is taken by someone staring at ther laptop screen.

And, yes, I gladly spend $5.00 to sit and work for a few hours at Starbucks quite often. The coffee? That's not the point at all.

September 29 2011 at 6:37 PM Report abuse rate up rate down Reply
mclaughlinlin

Getting a coffee at Starbucks is a small luxury in a poor economy. I don't agree that Starbucks is shortsighted and potentially canibalizing their business by offering Keurig coffee makers and K-cups. They've sold bags of their coffee and mugs in their stores for years. In fact I'm pretty sure I've seen premium coffee makers for sale there and I've never been tempted. It's a completely different experience to brew it at home Vs. "go out for coffee" in the store that keeps people coming back. I also think a competitive advantage is the emphasis they must put on personality as a hiring trait of primary importance; as a customer I've found the consistent friendliness to be a compelling reason to stop in.

September 29 2011 at 2:16 PM Report abuse rate up rate down Reply
dabrownman

They have already been jolted back from the dead. Have you seen their stock price? It's up almost 100% in 2 years.

September 29 2011 at 1:10 PM Report abuse rate up rate down Reply
KKiegiel

Green Mountain and Keurig coffee is the worst (hands down). I did try it and can vouch for that statement along with Consumer Reports. Dunkin Donuts is ok at best (I see national saturation troublesome). Most coffee that is on the supermarket shelves is sour. I see people buying coffee in droves at starbucks because I do travel. Satellite sites will obviously be much slower. Overseas operations are doing a k illing and growing (seems they cannot get enough of this stuff).

September 29 2011 at 12:28 PM Report abuse rate up rate down Reply