Is the Verismo a Flop? How Starbucks Investors Should Respond.

Starbucks (NASDAQ: SBUX) continues to try to invade our kitchens.

This time their goal is to create the perfect home-brewed espresso beverage with their long-anticipated Verismo 580 machine.  After much hype this autumn, the official verdict remains to be seen.  The jury is still out on whether the Verismo will be profitable for Starbucks, or a flop.  I’m betting on the latter.

Questions about the Verismo
Does it deliver what it promises?  How will this effect Starbucks’s revenues over the next several months?  Is there any meaningful impact on you and me–the Starbucks investor?  As a former Starbucks barista, self-proclaimed coffee snob, Starbucks investor and true believer in the Starbucks’ worldwide movement, I think there is, and I’m here to help.

Does the Verismo live up to its hype?
In a word: no.  Doing some hands-on undercover reporting, I’ve sampled Verismo-made espresso, plain lattes and flavored lattes from different Starbucks stores in my town–and have been left wanting with each beverage.  Though decent, the Verismo-made espresso just isn’t as smooth and silky as is an in-store espresso.  In addition, the Versimo lattes leave much to be desired, with the “milk” tasting a little . . . off.

The mystique is also notably absent.  Part of the Starbucks experience is waiting in a crowded line to order your special drink, then hob-nobbing with the baristas as they create your beverage to perfection.  A little machine on your kitchen counter — trendy as it may look — just isn’t the same.

Don’t believe me?  Notice that the Verismo machines were prominently displayed in the front of each Starbucks store a month or two ago.  Now, the machines sit alone in a corner, collecting dust.  Even the baristas seem to know that it delivers an inferior product — squirming as I ask them for a sample.

So, this critic gives the Versimo a thumbs-down.  Unless significant improvements are made, you’ll not find a Verismo in my kitchen.

How will this product affect revenue at Starbucks?
Starbucks will release its first-quarter fiscal 2013 financial results after the market closes on Jan. 24.  I’m predicting that Verismo sales for our coffee bean behemoth will be weak, but not terrible.  The disappointing numbers will come in over the next year, as people realize that they should have not bought according to the hype, but according to their palates.  The first-generation Verismo is destined to become a $199 dust collector on the counters of urban-chic and suburban kitchens.

Thankfully, poor Verismo sales will only create a small dent in Starbucks’ formidable armor.  Operating cash flows have come in between $1.61 billion-$1.75 billion over the past three quarters.  On its balance sheet sits more than $2 billion in cash and less than $600 million in total debt.  Additionally, coffee futures remain near two-year lows, which will continue to complement Starbucks’ incredible pricing power.

How do disappointing Verismo sales affect us as investors?
I mentioned earlier that Starbucks will release its Q1 financials on Jan. 24.  I’m guessing that their numbers will be solid, but possibly slightly below expectations.  Analysts will dig into the numbers and find that lackluster Verismo sales are contributing to decreased earnings, and the alarms will be sounded.

The market will probably overreact, dropping the SBUX share price from the mid-$50s to the low-$50s or high-$40s.  This is not all bad, as the share price comes at a current lofty price-to-earnings (P/E) ratio of 30.

Should you sell? Absolutely not. Thanks to CEO and Chairman Howard Schultz’s restored leadership and vision, Starbucks is on the verge of its next leg up in worldwide growth.  I wrote about this phenomenon in a recent article here.  Notably, this includes its recent purchase of Teavana to further solidify its commitment to win over both China and India over the next decade.  This will result in massive new areas of near-monopolistic growth for an already enormous company.

In addition, since I wrote my last article, Caribou Coffee (NASDAQ: CBOU) has announced plans to be purchased and taken private by Joh. A. Benckiser Group.  This essentially leaves SBUX as a stand-alone giant in the trendy, worldwide coffee (and now, tea!) movement.  Investing in this movement means investing in Starbucks.

Final thoughts
If you’ve been thinking of purchasing Starbucks shares recently, but don’t know if you’ve missed your window of opportunity, I suggest waiting until after Jan. 24.  As a bonafide coffee snob, I’m confident that Verismo sales will be a bit of a drag on this wonderful company’s revenues and profits over the next few quarters, bringing down the somewhat lofty share price in the near-term.  Use any dip in price to purchase some shares.  Alternatively, when and if the share price drops, consider selling to open puts on Starbucks at prices in the upper $40s–a great way to earn income!

Lastly, I hear that Starbucks’ Chairman and CEO Howard Schultz is a nice, down-to-earth guy.  Maybe next time, he will call me and ask for my opinion before investing millions of dollars on a less-than-perfect home espresso machine.  If you’re reading this, Howard, look me up!

Jeffrey W. Ross, MD is a Motley Fool investment freelancer.

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