Starbucks: A grande buying opportunity

By Jon Markman

Of all the adjectives in the dictionary, "cheap" is not the one that normally leaps to mind when you're talking about Starbucks (SBUX, news, msgs). Ubiquitous, crowded, cheery, kinetic? Sure, all of the above. But not cheap.

Yet that's the word of the day for investors when it comes to the inventor of the $3 cup of coffee right now. A wave of competitive threats -- some real, but most wispier than foam on a nonfat cappuccino -- have shoved its shares to their lowest point, on a valuation basis, in the past five years.

I'm not saying Starbucks is as cheap as a sip of water at a public drinking fountain; compared with most companies, its forward-looking price-earnings multiple, at 28, is rich. But Starbucks isn't most companies. It is one of the most consistent profit machines the world has ever seen, selling the Holy Grail of consumer products: one that is highly addictive but nonlethal. And so this is one bargain-shopping opportunity that investors should not miss.

A shareholders meeting on Wednesday gave the company a chance to tell its story, and predictably skeptics emerged to shout it down. But I want you to listen to your jitterbugging, caffeine-loving, hyperactive heart this week and think about how deeply this company has managed to insinuate itself into most Americans' lives by innovating endlessly on the theme of selling bean-flavored water.

A reliable addiction

Demand for the middle class' favorite drug will remain insatiate for many years to come, as Starbucks has not come close to saturating its potential market, regardless of the number of times you've seen three in a single downtown building. It will open at least 2,500 new stores this year, a pace that it began in the first quarter by opening 728 outlets -- or one every three hours.

At this rate, it will double its total number of stores by 2012. While it would seem that this could harm the business, instead this kind of pace increases margins by allowing the company to leverage its tremendous investment in back-office systems and distribution.

If you think about it, the value of the brand is undiminished after all these years. Many, if not most, of you start your morning with a trip to the local Starbucks, where you are greeted by the scent of roasted coffee and the sound of steaming milk. You declare your drink in the patois of insiders -- extra hot, skinny, no foam or drip -- to a friendly barista in that familiar green uniform. Feels like home.

After waiting just a moment in a room buzzing with guitar-flecked alt rock and light chatter, you are soon handed a beverage in the white cup dotted with a happy mermaid. Do you lounge for a few minutes, bantering with the barista, or scurry along to work? Either way, you have just had what Chairman Howard Schultz calls the "Starbucks experience."

This was the subject of an internal memo he penned on Valentine's Day, which ended up on the pages of The Wall Street Journal. In it, he expressed concern that as Starbucks has grown from 1,000 to 13,000 stores over the last 10 years, the famous coffee roaster has lost its edge.

Schultz thinks the experience has been watered down, and that the company faces "what some might call the commoditization of our brand."

Changed brew

His message resonates. Instead of feeling like a small-time coffeehouse, Starbucks is beginning to act its size. No more open bins of roasted coffee beans. No more sexy, manually operated La Marzocca espresso machines. Instead, automated machines are fed from "flavor locked" bags.

This, combined with weakening margins, slightly slowing same-store sales numbers and a few strong new rivals, had many wondering if Starbucks was beginning to lose its way.

• Video: Food fight: Starbucks vs. McDonald's

The company's recently announced plans to grow to 40,000 locations worldwide seemed unrealistic to many. Sentiment soured. Shares tumbled. Then, adding insult to injury, Consumer Reports ranked McDonald's (MCD, news, msgs) new premium coffee over Starbucks' brew.

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