Monday, November 19, 2007

Shorting Starbucks Paid Off Big. Time to Cover?

Regular readers of this blog know that I have been bearish on Starbucks (SBUX) for quite some time. Here is what I said in August 2006:

Perhaps the latest Starbucks report is a harbinger of things to come. Starbucks reported disappointing growth and the stock took a big hit. Management blamed it on too much demand for blended drinks that take a long time to prepare. That's unique. Growth slowed because demand was too strong. With gasoline prices pushing north of $3 per gallon, I suspect the real story is that consumers are wondering how much sense it makes to pay $16 a gallon or more for coffee.

In October of that year I said:

Starbucks is another stock that appears overvalued. It is selling for 51 times expected earnings, almost 4 times sales, and 11 times book value. That seems like a lot to pay for what amounts to a chain of restaurants. Of course, Starbucks has tremendous growth prospects, but that doesn't warrant buying the stock at any price.

In May 2007 when gasoline prices broke above $3.20 per gallon, I said:

Companies like Starbucks and Whole Foods that sell overpriced and unnecessary goods might find that growth will slow. These two stocks have already fallen well off their highs. Chances are they will go lower still.

And in July 2007, after Starbucks announced a price increase that came out to nine cents per cup on average, I warned:

There seems to be little skepticism on Wall Street about Starbucks' recently announced price increase. The company admitted again that higher costs are pinching profits. It is struggling with higher dairy prices, higher fuel prices, and higher energy prices.

Well last week Starbucks announced earnings and the stock got hammered. Although the company continues to make good money, growth is slowing. Worse, store traffic actually fell. It seems that even Starbucks addicts are not able to cope with the latest price increase.

This company is caught between a rock and a hard place. Does it raise prices to protect margins at the risk of lower volumes? Or does it hold the line, absorb higher costs, and watch margins shrink? Of course, if dairy or energy prices were to start falling, Starbucks would become a buy once again. But it's not yet time to start buying the stock. However, if you shorted Starbucks at much higher levels, you may want to start thinking about covering at least part of your position.