By Patricia Sellers
November 11, 2008

Starbucks CEO Howard Schultz needs less optimism and a stronger dose of reality in his brew.

Monday’s fourth-quarter earnings report — net income down 97% to $5.4 million on revenues of $2.5 billion, which were up 3% — missed expectations. Same-store sales, down 8% in the United StatesĀ and 7% globally, were worse than Wall Street predicted. Moreover, $170 million in restructuring costs to close 600 U.S. stores, as detailed by management in a conference call with analysts, is significantly higher than the company’s estimates four months ago.

The string of bad news has Wall Street now viewing Starbucks as, in the words of Bank of America’s Joe Buckley, “a broken growth stock.”

The entrepreneurial optimism and clever marketing that Schultz used to create one of the world’s best brands now seems to be interfering with Starbucks’ turnaround. Two weeks ago, when I talked with the CEO at his company’s leadership confab for managers in New Orleans, he bristled at my query about a turnaround. “I don’t use that term, by the way,” he replied, noting that he prefers “transformation agenda.”

Some former believers view “transformational agenda” as spin. “I see Howie still prefers euphemisms rather than speaking the truth straight out, and he wonders why his company is in the dumps,” wrote one person on Starbucks Gossip.com. The site is a poor source for facts but a worthy barometer of rank-and-file and investor sentiment. After Schultz, on Monday’s analyst call, cited the company’s Election Day coffee giveway as a “highly creative and relatively low-cost” way to drive traffic to the stores, another commenter wrote, “Wow, if you give away free product, people will come to your stores to get that free product.”

Schultz’s transformation agenda, incidentally, comprises “seven big moves” around a three-part strategy, according to the plan that he detailed to employees after firing CEO Jim Donald last January. The three elements of Schultz’s strategy are: strengthen the core, elevate the experience, and invest and grow. And the seven big moves? Be the undisputed coffee authority. Engage and inspire our partners (Schultz’s term for employees). Ignite the emotional attachment with our customers. Expand our global presence — while making each store the heart of the local neighborhood. Be a leader in ethical sourcing and environmental impact. Create innovative growth platforms worthy of our coffee. Deliver a sustainable economic model.

This all makes sense, and Starbucks has launched several programs to drive sales without the sort of generic discounting that would mar its premiere brand image: a new money-saving Gold card for loyal customers, a promotion at Costco — five $20 Starbucks cards for $79.95 — that’s outperforming expectations, and a holiday partnership with Bono’s humanitarian Product RED that will launch in stores Nov. 28.

But some of Schultz’s moves look too much like show and tell. He told me that “100% transparency with our own people…and decisiveness” are the two smartest things he’s done since retaking the CEO position and cited as evidence last February’s much-publicized store closings to train and energize its employees — er, partners. Many saw the three-hour closings as a gimmick, as I noted to him. “It wasn’t, but you know….” Schultz replied, his voice trailing off.

“If you freeze the frame and not look at the stock price, consider that we have 16,000 stores in 48 countries serving 50 million customers a week,” he told me. “The company is highly, highly profitable. But we have a downturn in our performance, most of which is due to the most serious economic downturn in our lifetimes.”

Indeed, the worst consumer spending trend in 28 years is crippling every retailer except McDonald’s , which surprised on the upside with an 8% rise in October same-store sales, and Wal-Mart , which is due to report earnings on Thursday. Trouble is, Starbucks is not highly, highly profitable right now. And investors can’t freeze the frame and ignore the stock price. The 52% decline in Starbucks’ share price year-to-date is all too real.

You May Like