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Thursday, May 27, 2010

Market Back in Love with Starbucks -- What's Next? SSW, FLWS, BIDZ?

Last September, we wrote that "the Market" was again embracing Yahoo! (YHOO), evidenced by a higher share price and Wall Street brokerage upgrades to "Buy" from "Hold" (*although mixed views remain - WSJ's Heard on the Street column today: Yahoo's Chase to the Bottom). Since last fall, the same thing has happened with a number of companies, including Starbucks (SBUX).

In April, the coffee chain received more attention on the back of improved results -- upgrades and/or higher estimates and "target prices" -- from TheStreet.com:
  • Starbucks (SBUX) upgraded at Jesup & Lamont from Hold to Buy. $32 price target. Company is seeing better sales across the globe.
  • Starbucks (SBUX) target, estimates higher at Barclays. SBUX price target jumped to $28 from $21 as 2Q10 upside was impressive. 2010 and 2011 EPS estimates raised to $1.28 and $1.50, respectively.
  • Starbucks (SBUX) estimates, target boosted at Goldman. SBUX estimates were raised through $28. Estimates were increased, given better same-store sales and costs. Neutral rating.
Of course, the stock's already had a fantastic run over the past year - two year chart from Yahoo! Finance:

Hindsight is 20/20, but the time to buy was in late 2008 or early 2009. We personally can't claim too much credit as we didn't purchase the stock -- our funds were tied up and/or allocated elsewhere, including other totally discarded names. However, we did advise family to purchase shares in the company in the low teens and below with the following summary thesis:
  • We know plenty of loyal Starbucks patrons and continue to see long lines at the ubiquitous franchise everywhere. Looking beyond the current economic downturn, odds seems fairly certain that Starbucks will remain “brand-addictive” and generate significant free cash flow for years to come, especially as the company dials back capital expenditures. We expect share buybacks will continue and see potential for a dividend.
Although we still like the franchise and would love to own a piece of Starbucks, we'll take a pass, even with the recently announced dividend (1.6% current yield). At 19-times consensus fiscal 2011 EPS and with modest forward growth expectations, shares are likely in a fair value range.

The Market has come around to the idea that (1) competition from McDonald's (MCD) and Dunken Donuts won't kill a resilient Starbucks, and (2) even a fairly mature franchise can return significant capital to shareholders over time. On the latter point, think of Berkshire Hathaway's (BRK-A, BRK-B) Dairy Queen. DQ is likely a slow growth business that faces constant competition from Friendly's, Sonic (SONC), Cold Stone Creamery, and all the rest, yet the company no doubt generates gobs of free cash flow that Berkshire can invest as it pleases.

What companies will the Market embrace next? Hard to know for sure. We mentioned the other week that the Market is coming around to our shipping companies, including Seaspan (SSW). Despite economic jitters resurfacing almost daily -- with headlines such as "Market Down on Renewed Europe Concerns" followed by "Stocks Jump After China Shows Confidence" -- our view is that conditions are on the mend. This view is supported by hard data and various economic indicators -- give a look at this, from the Conference Board today for Europe:
Of course, tomorrow or Monday, headlines may read "Stocks Down on New Risks in Europe [or elsewhere]".

Ignoring volatile, macro-related headlines to focus on corporate fundamentals and intrinsic values, we continue to believe that 1-800-Flowers.com (FLWS) and even totally discarded Bidz.com (BIDZ) remain at meaningful discounts to reasonable estimates of fair value. In each case -- while acknowledging that a weak consumer environment is an ongoing risk -- we see stabilizing results for established, well-positioned e-commerce franchises. Both have healthy balance sheets and potential for a return to Y/Y growth later this year, which might garner more Market attention. We've been wrong on Bidz.com over the past year, but we remain patient and are aware that illiquid micro-cap companies may swing widely and/or remain out of favor for extended periods of time. Lastly, although some insiders continue to quietly sell through "automatic" plans -- which we don't like, even if only slightly reducing their approximate >60% ownership position -- many other overhangs on the Bidz story are now gone and, as noted, fundamentals are poised for improvement.

Happy investing,

Jeffrey Walkenhorst

Disclosure: long YHOO, BRK-B, SSW, FLWS, BIDZ.

© 2010 Jeffrey Walkenhorst
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