Starbucks (SBUX) Chases The Economy Towards Its Bottom

Starbucks (SBUX) posted its first loss as a public company but gave investors something to hang on to. It reaffirmed that it will do better in fiscal 2009. To do that the company has to assume that a series of expense cuts coupled with better sales will cause a rebound in earnings.

Not likely.

The flaw in Starbucks plan sits on its foundation. The company’s management continues to believe that there is a long-term demand for expensive coffee which can be resurrected through a simple recovery in economic conditions. Even new competition cannot foul the plan.

What is much more likely is that Starbucks has become a mature company, at least in the US, in almost every sense of the word. Its domestic revenue will no longer grow quickly. Managing the operation becomes an exercise of cost containment.

All of that is to say that, particularly in an economy which profoundly undermines consumer spending, Starbucks has cut far too few stores and that its relative optimism will come back to haunt it.

Starkbucks has over 11,000 stores in the US and over 7,000 of those are operated by the company. By closing 600 stores, supposedly the worst performing outlets, it has probably taken less than 5% of its real revenue creating capacity off-line. That is not nearly enough.

In the last quarter, Starbucks US revenue grew only 5.8%. Growth for the trailing three quarters was closer to 10%. That sort of deceleration means that the US could begin to experience negative year-over-year revenue growth as the recession deepens and customer turn to alternatives.

While Starbucks is still growing at a 24% pace outside the US, the days of that kind of improvement in America are over. Starbucks has lost the earnings leverage that growth in its largest market brought.

To get EPS improvement back, Starbucks will probably have to close another 500 to 1,000 stores in the US. By taking shutting down more of the weakest locations the company stands an excellent chance of keeping most of its revenue and chopping a significant amounts of its costs.

Starbucks can hold the line on store closings and stay well behind the economic curve. That will drive more weak quarters and modest cuts which could go on for a year or more.

It is the same model that the US auto industry has used for years.

Douglas A. McIntyre