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Too much froth in Starbucks' stock?
Investors are paying more than 50 times earnings for what is, essentially, a well-run food service business.
By Robert Walberg
Starbucks is up big today in response to its generally bullish earnings report. However, given that theres more froth in the stock price than in one of the companys cappuccinos, investors will want to guard against chasing the stock.
Just as I have a hard time understanding why someone would plunk down $3.50 for a cup of coffee, I find it bewildering that investors continue to pay upward of 50 times next year's earnings for the stock. Starbucks (SBUX, news, msgs) is nothing more than a well-run food service business, and there arent many of those that regularly command such a premium to the market.
Admittedly, Starbucks management team has done an exceptional job of defining the marketplace and managing its meteoric growth. In little more than 15 years, the company has gone from fledgling coffee shop to an 11,225-store java juggernaut.
Whats amazing is that the company continues to grow at a rapid pace even now. While it might seem like theres already a Starbucks on every city block, the company plans to open an additional 1,300 stores in the United States this year. And dont let it be said that America doesnt export anything anymore: Starbucks will expand its global operations by another 500 stores this year, as well.
A double-shot
Just how many stores can Starbucks ultimately manage to open before hitting the saturation point? Management says that number is about 30,000, or more than double the current store count. Maybe thats why investors continue to pay a healthy premium for the stock. By that reasoning, if Starbucks could achieve 20%-25% annual growth thus far, whats to say that it wont do so going forward as well?
There was certainly nothing in last nights report to suggest otherwise. Fiscal second-quarter net earnings jumped 27% on a 24% rise in revenues. The company also indicated that the first month of operations in its fiscal third quarter saw sales improve by 23%. Management upped its full-year earnings guidance to 71 to 72 cents a share, from 68 to 70 cents.
But there are a couple of minor sticking points. First, operating expenses are on the rise due in part to increased payroll expenditures associated with company expansion. General administrative expenses as a percentage of overall revenue also increased.
Now, one quarter does not a trend make, but investors will want to keep an eye on costs and margins to make sure that the company is effectively managing its growth.
Time to sell
The other concern investors should have with the stock is that it looks like the good news was already baked in. Going into todays session, Starbucks stock was up by 26% year-to-date and by a whopping 64% since bottoming last September. Even using the updated guidance for the remainder of this year, the stock is trading at about 52 times next year's estimated earnings, or better than two times its growth rate. It should also be noted that the stock is trading at the high end of its five-year price-to-earnings range.
Starbucks began May trading well above its 200-day moving average. The last time there was such a divergence between the stock and its long-term moving average was back in early January 2005. Interestingly, the stock dropped nearly 31% over the next few months.
Im betting that a similar fate is in store for the stock over the next few months, as Starbucks is about to fall below its 50-day moving average for the first time in months. Now, with the earnings announcement behind us, there are no catalysts to spark the next wave of buying. I will short the stock in my Street Patrol portfolio as of todays close. Key support is in the $30 to $32 area.
At the time of publication, Robert Walberg did not own or control shares of companies mentioned in this column.
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