The Brand That Burns: Lessons From Starbucks, Whole Foods

Editor's Note: Herb Greenberg's column runs exclusively on RealMoney.com; this is a special free look at his column. For a free trial subscription to RealMoney.com, click here. This article was published May 9, 2002 on RealMoney.

I said something at our hedge fund conference in Miami last week, right there in front of 100 people, that I've never before put in print: If I ever run into Howard Schultz of Starbucks(SBUX Quote), I'll tell him I was wrong, over the years, to have written negative commentary about his company.

Not that I didn't have my reasons: Starbucks, from time to time, looked like an accident waiting to happen.

In its early years, the knock on Starbucks was that it would suffer from the TCBY syndrome: Just as the frozen yogurt company got smacked by competition (as yogurt stands sprouted on every block), the same would surely happen to coffee. But it didn't.

Then came the valuation worry: Starbucks was simply the most expensive company in the restaurant industry.

Finally, there was the spreading-itself-too-thin theory: that as Starbucks expanded its brand into supermarkets, it would sacrifice margins for shelf space.

Reality, regardless of whether you like its coffee: Starbucks created a super brand that didn't really seem to cannibalize itself as stores percolated blocks from one another. Consumers actually sought out the predictability of its brand. It became a sure-bet coffee away from home.

Valuation was irrelevant because it really isn't a restaurant in the true restaurant sense and the company kept executing and kept coming up with something new to counter one or two bad months or quarters. And when something didn't work (such as its short-lived foray into the Internet space), Starbucks was quick to cut its losses.

As for low margins from grocery store distribution: Who cares? Last time I looked they seem to be getting more shelf space, not less.

Lesson learned: Unless there are serious accounting problems that don't get caught and fixed, a strong brand is a strong brand is a strong brand. Even strong brands do eventually hit the wall, as some skeptics think Starbucks will do sooner rather than later. Of course, they've been thinking that for 10 years and eventually the skeptics will be right. It's just that surely there must be easier ways to make a buck (or write a tension-filled column) than betting against a strong brand, especially a well-executed brand with growth staring it in the face, run by a passionate and talented manager, as was the case with Starbucks.

Donning the Dunce Cap

All of this is a long-winded way to say: I've removed the "incomplete" I gave myself for raising questions about Whole Foods(WFMI Quote), and instead given myself, my sources and my column failing marks. (Just as Cramer used to have his analysts tape the names of losing stocks on post-its to their foreheads -- really, he claims that when he was at his maniacal worst he did that! -- I'm sitting here wearing a dunce cap.)

While Whole Foods had its earnings quality issues a while back, and while it has had a series of key management defections, and while I've wondered whether in light of those defections the company could execute on an ambitious expansion program, truth is: People like shopping there and comp store sales aren't going down.

Is the stock cheap? Is it expensive? That's for you to decide, but the bear story has never been borne out. (I keep hearing my buddy Jeff Matthews telling me that stocks aren't a religion. Well, no, maybe they aren't, Jeff, but some stocks are good stories! And this one was and at some point may be again.)

Furthermore, high and steady stock prices give companies like Whole Foods the ability to self-finance future growth, which will continue to fuel earnings and revenue growth unless they royally screw up. You could say the same for restaurant stocks like P.F. Chang's(PFCB Quote) and Panera(PNRA Quote), though both are at ridiculously high valuations. (And this note: P.F. Chang's is far less self-promoting than Panera, which had the audacity to say that a recent stock split is "another indication of our confidence in our future results." But splits have nothing to do with results!)

Life is a series of lessons, and the final lesson is not to waste time or energy questioning good brands, especially those early in their life cycles. It's a lesson I'm bound to forget; make sure to remind me when I do.

---

Editor's Note: On Tuesday, May 7, 2002, we discontinued the email service that alerts some RealMoney users that a new Herb Greenberg column has posted. If you would like to continue receiving these email notifications, click here for information on the new service.