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Greggs PLC Set to 2x Revenues and Expand to 3,000 Stores
A thing of beauty, Greggs, the nation's favourite pie-joint has ambitions to expand store count to 3,000 and 2x revenues to £2.4B within the next 5 years $GRG.

CapEx is expected to be ~£600M over the next 3Y, nearly 3x prior 3Y.

Assuming all else equal, if the multiple (using earnings here) stayed flat and earnings as a % of sales was roughly the same as it has been historically, then somewhere between 55% to 95% ish over 5Y.

Naturally, the multiple could go the other way.

Currently writing something up on Greggs, so will have some longer form thoughts soon. Anyone own this one?
post mediapost media
Greggs seems to have a pretty low CAPEX. Do they not own the stores?
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Interview, Edmund Simms at Valuabl
Good morning,

Today I am thrilled to share a discussion I had with Edmund Simms @valuabl, the author of the Little Book of Big Bubbles, a fund manager, and owner of the Valuabl newsletter. Having spent time across multiple corners of the market (hedge funds, mutual funds, and VC) Edmund now runs his own fund, which opened its doors in 2016.

We talk about how that journey played out, what “value” really means, correlation and standard deviation, luck & skill, the delivery business, bubbles, and a lot more. Much like the writing style I have come to adore in Valuabl, Edmund offers up an array of witty analogies and imagery in his responses to today’s questions. I hope you will enjoy this as much as I did.

Conor: Hello Edmund, thanks for taking time out of your day to answer some questions for Investment Talk readers. You are a fund manager, you have authored a book, and you also write the Valuabl newsletter. So, there’s a lot to pick through today, but for the benefit of the reader, I thought it would be great to hear about your backstory. I know you’ve spent time across hedge funds, mutual funds, and VC, and later opened up a long-only fund in 2016, so it would be awesome to hear about that journey, and what incentivised you to open a fund.

Edmund Simms: It’s my pleasure, Conor. I hope to give stimulating answers and avoid boring your discerning readers.

I will start at the beginning. I grew up in the middle of Australia. My father was a drover and my mother was a jillaroo. We moved to a small town just south of Sydney when I was seven. By adolescence, I had decided against becoming a fireman and set my mind on golf, becoming respectable but not good enough for the American professional tour. I had a keen interest in maths throughout school, so I enrolled in a mathematics degree at the University of Sydney.

The friends I made at university mainly studied business, economics and finance—it fascinated me. I added these courses and a concurrent second degree in finance. Struggling to figure out my style and approach, I decided to work in as many roles and read as many books as possible until I figured myself out and found a congruent approach. By cold-emailing hundreds of people in the industry, offering to shout them a coffee and not poach more than 20 minutes of their time, I got information on how they thought about their role and where they thought I would fit.

I first took a position at a boutique quant-fund run by two brilliant American fellas. The work was fascinating, and they were patient with me. They spent a profligate amount of time debating with and teaching me. In the end, though, I decided the quant world wasn’t for me so went to work for a capital placement agent, for a venture capitalist, for a startup, and then finally in the value team of an international mutual fund. This one struck a cord, but I was still restless.

Australia is beautiful but geographically and culturally isolated. I wanted to see the world. Further, the desire to start a fund and do it my way was percolating in the back of my mind. I tossed up between moving to London or New York with the mutual fund and settled on London. After a year there, I left that team to strike out on my own. And here we are.

Conor: Before we dive into your investing style, I’d be curious to hear you riff on how you found each of those environments (HF, MF, VC, and operating your own fund) and the different skill sets required for each. I ask this, because I know we have a lot of younger readers, who might not be sure which direction they want to head.

Edmund Simms: I am lucky. I was in small teams at small shops. My mentors were operators and deep thinkers who were generous with their time and knowledge. I cannot speak to the general environment, if there is one, of each stream. My advice is to think about the problem in reverse: what would you most regret doing when you look back from your deathbed? I am yet to meet anyone who says, "I wish I spent more time working for the boss I didn't respect," or, "I wish I spent more time on busywork."

It's natural to want to find the optimal path. But there are so many roads that it makes looking at the map overwhelming. Instead of trying to make every shot a miracle one, to use a golf metaphor, look for the water hazards and avoid them. Sure, the fat bloke in the cart on the adjacent hole might not be impressed, but who cares. In his own words, Jack Nicklaus was a lousy bunker player but an excellent lag putter—so he aimed away from bunkers and to the fat part of the green. Figure out what turns you on or off, and play the game in a way congruent to that.

Conor: You have stated in the past that you simply buy “value”, in the order of anywhere between 5 to 15 uncorrelated positions.

Can you talk to us about what “value” means to you, why correlation (or lack thereof) is so important, and how you tend to think about positioning/discovering that balance of non-correlation?

Edmund Simms: Value is the gap between what something is worth and the sale price. Value is a duffle bag stuffed with a half-million in cash that I can buy for $100,000. We intuit this every day but seem to forget it apropos stocks. The squiggly lines gyrating seductively across our screens seem to reach out from the pixels and enchant us like the lights on a casino floor.

If I offered to sell you a suitcase of money, you wouldn't go to your Bloomberg, look for the price of money bags, and consider whether you could sell it to someone for more in the future. You would ask, "how much cash is in there, when will you deliver it to me, how can I be sure, and what are my other options?"

If you accept my offer, many things can go wrong: what if I'm a shyster, or something happens to me on the way to make the drop, or there is less cash than you expect? You want protection by risking as little money as possible and ensuring a large gap between what you expect and pay. Moreover, you wouldn't want to put all your eggs in my one basket; you would diversify. If I'm a crook, my partners probably are too. If I am caught in an inferno, so are the others in my building. You would look for deals on other bags in faraway places that can make the drop regardless of what happens to me. Correlation and value are about protection.

You want protection if your assessment of me and my promise to make the drop is wrong. If I tell you there's a million in there, but I lie, and there's only half, you'd still have made a satisfactory return paying a quarter—the value side of the equation. But if something happens, and all the people delivering bags of cash to you are on the same bus as it explodes, your business is toast—the correlation side of the equation. The calculus of this cash-dropping empire you're building becomes more nuanced as the overlap between bag-droppers and potential return increases. Where do you draw the line between diversifying and increasing returns? If some friends of mine can give you large bags of cash at hefty discounts, you have to weigh that opportunity against how likely we are to be in cahoots to rip you off.

I demand new opportunities for my portfolio to meet two criteria: First, they must be substantially undervalued. Second, they must either increase the portfolio's expected excess return, the expected annual rate of return above the risk-free rate, or decrease its volatility. The opportunity for return must be better than what I already have, or it must reduce the total amount of risk I face. There are mathematical approaches you can take here. I use a quarter-Kelly ratio. But the underlying reasoning is more important.

Conor: In an interview with Commonstock, you were once asked what uncommon investing views you hold. To which you responded:

“I don’t care about business quality. Your assessment of the business’s intrinsic value should include your quality assessment insofar as it affects value. If I am paying less for the same future cash flows on a risk-adjusted basis, I don’t care whether the business is a superstar or a stinker. If investors generally believe that a particular company is excellent, then it’s unlikely you’ll ever be able to buy it with a significant margin of safety.”

I was hoping you could possibly expand on this somewhat for us, maybe throwing in some specific examples of when you found this to be true?

Edmund Simms: Money doesn’t have a memory. It doesn’t know whether it came from a business with stout competitive advantages or you found it in a puddle on the side of the road. The crucial thing is how much a company is worth and how much you pay. Imagine, if you will, that your great-aunt Hortense has died. In her will, she proclaims that you can buy her house from her estate for a dollar on the condition that you never sell it. The house is rundown, haunted, sits on the edge of a cliff, and a grotesque older man with hooks for hands is the manager. Thrillseekers rent the house occasionally, and there is a small profit leftover which gets paid out to you each year.

Many analysts wouldn’t even consider looking at this asset. There’s no growth. There’s no price action because you can’t sell it. The manager is ugly. Climate change might accelerate the erosion of the cliff edge and collapse the house into the ocean. The asset is a stinker: “Buzz! Your business, woof!”

But you got it for a buck, and your return is enormous.

Of course, a better business is a better business. But that’s not where the puzzle ends. The second half of the equation is how much you pay. Many people are looking exclusively at companies they think are high quality. Because of this, these businesses tend to cost too much, while crummy ones get overlooked. A recent example is Frasers Group PLC (LON: FRAS, £3.2bn market cap). Formerly known as Sports Direct, it’s a British clothing and sporting goods retailer. It was run by its pudgy and incorrigible founder, operating in a declining industry in a country written off by many because of a rapidly shifting geopolitical landscape. By my estimate, in 2019, it was worth at least £6 per share but was trading below £2.50.

Conor: In that same interview, you remarked that the ability to recognise when one is the benefactor of luck, and not skill, is an underrated competence in investing. Sometimes we have a thesis, it doesn’t play out like we planned, but the stock market rewards us anyway. The foolish thing to do, would be to ascribe that reward to one’s own insight.
Obviously, sometimes we don’t get so lucky. I would love to hear about your process for identifying instances when you might be wrong, and the steps you take once you believe that might be true.

Edmund Simms: It’s impossible to separate luck from skill in the short term and with a small sample. My approach is to do the best job I can at playing a good hand, betting when the odds are in my favour, and assuming that every outcome over the short term is luck.
A wrong decision leading to a profitable outcome can be worse than a good decision that leads to loss. It conditions you to believe you know more than you do and are in control of more than you are. Overconfidence is a killer. It is the cognitive bias that Daniel Kahneman, a titan of psychology and behavioural finance, says he would most like to eliminate. “It leads governments to believe that wars are quickly winnable and capital projects will come in on budget despite statistics predicting exactly the opposite,” he says, before adding, “but it is built so deeply into the structure of the mind that you couldn’t change it without changing many other things.”

I worked as a croupier for a year when I was at university. For this job, all the blackjack dealers learnt to play statistically perfectly. Seeing people make the wrong call but win and attribute it to their brilliance, my moustache, the colour of their socks, or anything else unrelated was a sign they were going to lose it all. Routinely, these people doubled down again and again until it was all gone. Overconfidence is expensive.

We’re all dumber and less in control of the world than we think. Accept and embrace it.
I use a few unusual strategies: First, before I look at a stock, I commit to buying or selling it if it meets or misses my value and diversification criteria. Second, I only check the portfolio once a month unless specifically buying or selling something. Third, I value everything in my portfolio quarterly and from the ground up. Like using a stencil, you always trace off the original, never the copy. If a bias or a mistake crept into my previous work, I don’t want to build off and magnify it.

Conor: Whilst we are on the subject, my mind draws to diversification and downside protection. You spoke about owning a fairly concentrated basket of un-correlated companies. Some investors view their portfolio as a plethora of small bets, oft ignoring correlation. Others, like yourself I assume, view their portfolio with more of a risk-adjusted tint. The standard deviation of a portfolio doesn’t decline all too much if an investor continuously stuffs highly correlated stocks into their basket. As such, you could have someone with 50 stocks, enduring more volatility than someone with, say, 10 stocks, but with a greater focus on non-correlation.

What is your view of managing the standard deviation of your portfolio and diversification more broadly?

Edmund Simms: Investors need to ask themselves what their goal and time horizon is? Are you trying to beat the market, copy it, or have fun? If you’re trying to copy the market, buy an index and move on. If you’re trying to beat the market, the more stocks you own, the harder it is to do. By definition, you cannot outperform a basket of all the stocks by holding all the stocks.

Investors will want to consider how to diversify their bets best while giving weight to the best opportunities. As I outlined above, you can do this mathematically or intuitively. Modern Portfolio Theory (MPT), and mathematical derivations of it, get a bad wrap. It’s fun to parrot your inner Buffett or Munger and dunk on these approaches. But they work. Some have argued that Buffett has used an intuited version of MPT.

There is statistical evidence that adding assets with similar expected excess returns but little correlation or covariance to your portfolio improves your overall risk-adjusted expected return. A paper from the University of Cagliari, Italy, in 2020 demonstrated that the Kelly and Tangent Portfolios both dramatically outperform the Minimum Variance and Equal Weighting portfolios. Other studies show that marginal diversification benefits, the additional benefit of adding another asset, drop logarithmically. You get a considerable advantage going from one investment to two. But going from two to three, the marginal benefit drops. Additional research suggests that following a purely Kelly approach can be ruinous if the position sizes are too large because of overconfidence. The evidence suggests using a partial Kelly ratio is the best way to combat this.

Conor: Taking a step back for a moment, you share a lot of research outside of managing the fund. One avenue for that is the Valuabl Newsletter, to which I am a happy subscriber. You’ve been writing this since mid-2020, and I personally feel it’s one of the most underrated newsletters out there, with a lot of great valuation and macro work. I don’t say that lightly either.

Tell us about why you decided to create Valuabl, and maybe what your aspirations for the newsletter are?

Edmund Simms: Thank you, Conor. That is a stunning and humbling compliment.
I deeply admire great thinkers and crisp, persuasive writers. I want to be like them. I am not, but I will keep trying. Clarity of prose follows clarity of thought. Writing helps me to think, and thinking helps me to write. I get immense pleasure and satisfaction from it.

My hope for Valuabl is for it to become a financial and business-focused version of The Economist, brimming with deep analysis and investment ideas presented engagingly. On only two scores can Valuabl hope to outdo its rivals consistently: the quality of analysis, and the quality of writing. Both will always need to improve. I want Valuabl to educate, challenge and entertain investors long after I'm gone and one day become a pillar of the financial world.

Conor: Back in April, you shared a great write-up on Deliveroo, one of the UK’s food delivery competitors. For the Americans reading, think UberEats, Postmates, or DoorDash.
Delivery businesses like this are cumbersome. My view is that it’s a race to the bottom, the unit economics are not great, and to be successful one has to be the outright leader. At times, I feel that even 4-5 players in the market are far too many. With these businesses relying so much on external liquidity, liquidity which is now drying up, and evident consolidation already taking place, what are your thoughts on this space and what needs to happen before a clear, profitable leader is established, either in the EU or US markets?

Edmund Simms: For the last decade, capital has been abundant, increasingly cheap, and easy to get. At the same time, the short-haul delivery app market has had few barriers to entry. A small group can get together, build an app, and connect porters, customers, and restaurants. Thanks to these conditions, many delivery startups have spawned and expanded rapidly.

There are localised network effects that will drive the industry towards native oligopoly. It's no skin off the customer's nose to have four or five food delivery apps and switch between them. Still, that proposition is much more difficult for restaurants where even two or three concurrent systems become cumbersome. Deliverers, similarly, will struggle to manage more than two or three simultaneous roles. As a couple of companies take hold of a region, the efficient scale of that market becomes unattractive for new entrants to go after. It's a gangland turf war. Get your area and hold it.

Once the incumbents have taken control of the region, it's a race to the bottom. Price and convenience matter and excess profits will be difficult to generate. For the last few years, these companies have subsidised delivery costs with investor capital—this will stop as capital markets discriminate and costs to the consumer and restaurant will rise. These companies' economics and potential profitability are closer to typical delivery and logistics businesses than software as a service than many hope. These are labour intensive delivery business models applied to an adjacent market with a shiny app.

Conor: You also authored the book ‘The Little Book of Big Bubbles’, where you cover every bubble from the Romand Land Collapse in 33AD, to the Tulip Mania in 1637, the Japanese asset bubble of 1986, and even the beanie babies bubble in the mid-1990s.

Firstly, I am curious what motivated you to write that, and if you could boil down the world’s history of financial bubbles into one paragraph, what would be your core takeaway?

Edmund Simms: In early 2020, I had the early stages of a working hypothesis that there was a large and global residential land price bubble building. I decided to study past bubbles to figure out their similarities, build a framework for identifying bubbles that would have worked in the past, and see if my hypothesis held up against that.

My notes became a series of articles in Valuabl, but I wanted to share the lessons of history more accessibly and with a broader audience. So I decided to publish them as a short, easy to read recount and analysis of the main ten financial bubbles of the last 2,000 years. The core lesson is that human nature doesn’t change. Bubbles form, and we find ways to deceive ourselves that this time is different. Every bubble I studied followed the same arc: a fundamental shift caused a movement, speculators got involved and the pricing mechanism became a positive feedback loop driving prices up until it collapsed unexpectedly. Then the cycle rinses and repeats.

There are two conditions for a bubble: first, the pricing mechanism must be a positive feedback loop. People are buying because they expect the price to go up; and second, the expectations of the future implied by the price must be highly unlikely or impossible.

Conor: The book naturally concludes with the housing bubble of 2008. At the time of publishing, the events of 2020-2022 were (and are) still unfolding.

In a relative sense, these last two years might not have been as crazy as prior events, but there are pockets of the market that took aggressive elevators up in 2020 only to topple down the stairs violently in 2021/22. What have you made of these last two years, and do you think there were/are signs of a bubble in particular industries or asset classes?

Edmund Simms: The last few years have been dramatic for financial markets. Low-interest rates set off a chain reaction of rising prices and declarations of a new paradigm. Some of these pockets of the market were bubbles as they met the criteria and followed the bubble arc to a tee, but in aggregate, we didn't see an all-encompassing stock market bubble as big as some. The inflexion point was a rise in the price of money. Stock prices haven't come down; instead, the cost of money has gone up. This reversal has made many investors question what it is they own.

It is ghoulish to say, but the good thing about equity and stock market bubbles is that they inflate and deflate rapidly compared to others. In contrast, land price and credit bubbles are like great oil tankers on the ocean: they're huge, slow turning, and when they sink, everything gets slicked.

We are at the moribund of the largest, by my reckoning, global land price bubble ever. It's been building for a quarter-century in some places, which is in line with how long past land price bubbles have expanded, and a sustained rise in the rate of interest could pop it. I have penned ten pieces on the topic over the last 18 months for Valuabl and am comfortable letting those writings stand as my will and testament on the subject.

Conor: The last official question now, and I ask this one selfishly, as I do with all guests who are from, or reside, in the UK. The culture of investing in the UK is odd. There are over 10M residents funding a cash ISA account in the UK, compared to fewer than 2.5M funding stocks and share ISAs. For those unaware, a cash ISA is essentially a tax-exempt interest account on cash, whilst stocks and shares ISAs are an account that allows for up to £20K (~$26K) to be invested in stocks each year, with income and gains exempt from tax.
This alone blows my mind, but the UK generally has low participation rates. What are your thoughts on why this might be?

Edmund Simms: I will highlight two of my unusual views on this that your readers might find intriguing:

First, the average American is less risk-averse. Entrepreneurialism and optimism are abundant in the United States. That attitude, combined with deep capital markets and a myriad of opportunities, makes every part of the equity investment lifecycle across the pond attractive.

Second, like Antipodeans and Canadians, Brits have enjoyed a longer-running residential land price bubble in countries with a distinct cultural focus on homeownership. Why would you put money into stocks when houses earn more than the average wage, have outperformed equities, can be lived in, and are, in living memory, a no-loss proposal backed by the government and banking sector?

Conor: Lastly, where can readers find you and your work, and do you have any concluding items you’d like to say?

Edmund Simms: Readers can connect with me on Twitter (@valuablofficial), on Commonstock (commonstock.com/valuabl), and by subscribing to Valuabl (valuabl.substack.com), my fortnightly journal of the financial markets.
It’s been a pleasure sharing my thoughts and ideas with you. I hope you found them intriguing at the very least. I will leave you with the words of the great man, Leonardo da Vinci: “The noblest pleasure is the joy of understanding.”

Conor,

Author of Investment Talk
post mediapost media
Breaks over and I’m only at question 5; but my response for question 4 is: FINALLY, someone educated has my back. People act like you can only invest in 5-10 companies in the universe, that if there’s ANY negative news, you shouldn’t touch it, etc. Nice to see someone else who realizes that money can be made all over the place, and money doesn’t care how you made it🤙
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Curated Research and Articles
Market Talk is a bi-weekly Sunday issue, where I curate the best things I have consumed during the last two weeks.

Every second Sunday I will share:

• The greatest articles I have read during the last two weeks

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Comments from Me

This marks the 50th edition of Market Talk, and to celebrate, I’ll write 50 more editions. In other news, I have just wrapped up my first week off from all work in ~3 years. I make the effort to have a lot of fun in my life, but wow did I forget how much more there is to life than work and weekends. I spent most of the time being a tourist in my home country (Scotland), exploring the cities and areas I had not been to yet, as well as acquiring an Indian tourist visa. I feel refreshed, and thankfully the weather was superb for the duration of my time away.
General: Next week I should have one new write-up, and one new interview with an excellent guest who has spent time in hedge funds, mutual funds, VC, has authored a book, and now runs a fund.

UK Stocks: This year, I have been increasing my exposure to UK-domiciled stocks. I have had readers express interest in write-ups of this nature in the past, so you may be pleased to know there are some coming down the line.

Sponsors: Readers will know, that back in February, after nearly two years of writing Investment Talk, I removed the paywall. To help with the running costs of this newsletter, I figured Market Talk, which has always been free, would be a suitable place to allow sponsorships from time to time. No garbage, only brands I think are genuinely useful or of interest to readers. I hope you can understand that this allows me to keep grinding on Investment Talk and, candidly, it incentivises me too.

Recent Publications: Memos I have shared since the last Market Talk.

Interesting Reads

Here is a shortlist of a few interesting pieces that I have read over the course of the last two weeks, to feed your mind.

Note, that these articles are not listed in order of perceived value.

To access the suggested article, click the purple link after the source subheading.

1) The Makings of a Multibagger
Length: Dense Read


Okay, so first things first, this thing is 645 pages long. Certainly not a report you can consume in one sitting unless you are Warren Buffett. But it is a great resource to be tucked away and nibbled on over a period of time. Back in 2020, Alta Fox put together this monster report to discover the makings of a multi-bagger, by shining the torch on some of the best-performing stocks from the prior 5-years, identifying their common characteristics, trends, and catalysts, in an effort to identify strategies to discover the next set of high-performance stocks.

Alta Fox analyse 104 companies, each across 6 slides, outlining the quantitative and qualitative datasets including; an overview, the business model, competitive analysis, what investors missed, and key takeaways. Furthermore, the high-level and specific takeaways shared on slides 18 and 19 allow the reader to digest the findings in minutes.

A fun and insightful read, and one that may help with one’s own investment process. Naturally, there would have been a great deal of work behind each finding, more so than 6 slides can represent, but it highlights the importance of concise pitching and presentation.

2) Third Point First Quarter Letter
Length: Moderate Read

Source: (Third Point)

Dan Loeb and Third Point’s first quarterly letter of the year and the hedge fund manager details his decision to reduce exposure, giving the fund a cash position that prompts “buying power higher than at any time during the last 10 years”. Believing the best defence is a strong offence, Third Point has increased cash, reduced leverage, increased their short basket, and appears to be playing the commodities trade with large investments across energy and other cyclicals.

Pages 3 to 4, under the heading ‘Further Thoughts’ paint a particularly interesting viewpoint of regime changes, and how Loeb and Co plan to remain alert to avoid the risk of ruin, arguing that “the key, of course, is to change your framework when the environment changes”.

“Since I started Third Point 27 years ago, I have seen many investors (including myself) stumble after years of success because they did not adapt their models and frameworks quickly enough as conditions shifted. I have said before that they don’t ring a bell when the rules of the game are changing, but if you listen closely, you can hear a dog whistle. This seems to be such a time to listen for that high-pitched sound..”

3) Wealth Transfers: Redistribution of Value via Capital Allocation
Length: Moderate Read


A wealth transfer occurs when a company buys or sells a mispriced security. This memo by Mauboussin and Callahan explains the nuance surrounding when company purchases and sells its own stock, and the ramifications this may have on both new and existing holders of said stock.

Companies can influence the wealth of shareholders in various ways. They can reinvest into the operations of the business, hoping to generate an attractive ROI, in excess of the cost of said capital. However, this can be hard to sustain in certain market and/or competitive environments. During moments when management conducts dealings of mispriced shares, the duo find that most often, this actually results in selling high and buying low, which stands to benefit existing holders, with transacting holders (new) faring much worse.

“Astute investors focus on a management’s ability to allocate capital and tend to focus on investments in the business. This is appropriate. But investors should also be aware of the impact of management actions with regard to their own stock. The essential guide is the gap between price and value. Finally, many investors count on mispriced stocks regressing toward their value per share over time as a means to generate excess returns. Wealth transfers show that actions by management can change the value per share without any change in the underlying fundamentals of the operations”.

4) In Search of a Steady State: Inflation, Interest Rates and Value
Length: Moderate Read

In true Damodaran style, Aswath shared the academic overview of inflation, complete with the historical backdrop, how inflation impacts financial asset pricing, the economic consequences and what this could mean for the investors amongst us.

A must-read for those wondering how inflation might impact their portfolio today, and across the next few years. As hard as it might be to predict macro, it doesn’t hurt to be well informed. He posted a follow-up to this memo yesterday morning, for those interested.

“The inflation genie is out of the bottle, and if history is any guide, getting it back in is going to take time and create significant pain. It is the lesson that the US learned in the 1970s, and that other countries have learned or chosen to not learn from their own encounters with inflation. It is the reason that when inflation made itself visible in the early part of 2021, I argued that the Fed should take it seriously, and respond quickly, even if there existed the possibility that it was transient. Needless to say, the Fed and the administration chose a different path, one that can be described as whistling past the graveyard, not just ignoring the danger with happy talk, but also actively taking decisions that only exacerbated the danger. Needless to say, they now find themselves between a rock (more inflation) and a hard place (a recession), and while you may be tempted to say "I told you so", the truth is that we will all feel the pain.”

5) 10-K Navigation Guide
Length: Dense Read

Source: (Wolfe Research)

Of the nearly 8,000 people that read Investment Talk, there are investors on all points of the experience spectrum, and one should never be too proud to revisit the basics. This comprehensive, 229, report from Wolfe Research walks the reader through the ins and outs of navigating the 10-K filing.

A great resource for younger investors, or those looking to polish up their old skills.

“Graham and Dodd’s seminal book, Security Analysis, popularized financial statement analysis as a critical component of investing. It fostered the notion that a thorough reading and understanding of a company’s annual report would lead Wo identifying overlooked investment opportunities and potential risk exposures. In short, reading an annual report increased the odds of producing alpha. Perhaps even more so in a current environment dominated by ‘one’ decision momentum stocks, quantitative strategies, and passive investment flows. 10-K are larger than ever before with complicated accounting principles underlying the figures and footnotes. To assist investors in navigating through these lengthy documents, this report explains and interprets essential financial statement disclosures and GAAP accounting. We’ve arranged this report by key sections, following the typical 10-K progression, and wrote each section in such a way as each topic may be read individually.”

6) Hold Fast: Tips for 100 Baggers
Length: Light Read

Source: (Woodlock House)

No, the irony of sharing a “100 bagger” type memo at this moment in time is not lost on me. But the memo is good, and I like to read the works of all manner of investors. Discussing investors’ instincts to focus more on stock prices than LT fundamental health, Mayer highlights how this view can taint one’s narrative, and lead to suboptimal returns, whilst offering up a potential solution to help stay focussed on what really matters.

“And then he asks “Would a businessman seeing only those figures have been jumping in and out of the stock?” And he answers: “I doubt it.” I agree. Just look at those financials. That’s a healthy business. And if you held on for the whole 20 years, you were up something like 25x, excluding dividends. But how many people held on for that 25-bagger? Probably not many. As Phelps writes, the industry won’t let you. The industry conditions you to measure performance using quarterly or annual stock prices. You almost never see anyone print the results of their portfolio by showing you anything like this table. You don’t see anyone in their quarterly letter show you financial snapshots of the businesses in the portfolio, or track their progress for you like this. No, you see them write about stock prices being up this or down that. So people focus on stock prices.

Other Items I Read
Note: ($) indicates there is a paywall on this content.

• A Wealth of Common Sense: The 2 Types of Bear Markets
• Neuro Athletics: Tools for Managing Burnout
• Stratechery: Cable’s Last Laugh
• Net Interest: Dotcom 2.0
• Saga Partners: Q1 Shareholder Letter

🕵️ Company Related 🕵️
• Young Money Capital (FB): Instagram Write-up
• Enlightened Capital (APO): Apollo Global Write-up
• Bronte Capital (SWMA): Commentary on Swedish Match
• Holland Advisors (JDW): JD Wetherspoons Write-up
• Cedar Grove Capital (WOOF): Petco Write-Up
• Semi Analysis (INTC): Intel Write-Up

Something Interesting

The old saying, “history does not repeat itself, but it often rhymes” is something I wanted to touch on today. If readers remember edition 46 of Market Talk I shared some thoughts on the “Information Highway” narrative that later just became “The Internet”. Back in 2003, during this same period of ‘early internet’, the people at San Fran-based studio, Linden Lab, created a game titled “Second Life”. Launched three years after the ‘Sims’ game, another game that pioneered this passive living social experience game mechanic, Second Life marketed itself to be more than just a game, with founders proclaiming “There is no manufactured conflict, no set objective".

The project was created in 1999, with founder Phillip Rosedale seeking to create hardware that would allow users to become engulfed in a virtual world. With weak demand for the prototype, he later shifted course and settled for a software adaptation. Second Life promised escapism, avatars, its own currency, its own economy, and the ability to be whoever you wished to be in this new… second…life. Gaining popularity in 2005, the world soon had 1M users, before dwindling into the abyss. We could go down the wormhole here, but the point I wanted to make is that it’s eerily similar to what Facebook is attempting to do with their Reality Labs division. More specifically, Horizon Worlds.

Second Life (Left) and Horizon Worlds (Right)

The difference is that now we have the technology, the awareness and the demand to allow hardware to be a larger part of the equation. Since Second Life was born, the mobile phone became ‘the’ screen, and immersive experiences have slowly begun to migrate towards AR and VR, with some suspecting they could supplant the mobile as the new screen. The idea of ‘the metaverse’ is something which has existed for decades, in my opinion. We lead digital lives simply by presenting an alternate version of ourselves on Social Media. We build communities and meet friends on Reddit, on Twitter, through gaming, and even through apps like Tinder and Hinge. Meta’s vision simply accentuates that with VR, bringing the connectivity and interaction to a new, oft richer, level.

Is that good for humanity? Like the initial explosion of Facebook blue, and Instagram it’s easy to find flaws and consequences. But it’s also easy to underappreciate just how seismic of an impact it had on humans and their ability to connect, communicate, and form communities across the world. I feel that, if VR/AR ever does amount to a similarly explosive S-Curve of adoption, then it comes with its own unique set of foibles and benefits.

Personally, I have been making it a habit to leave my phone at home when I leave the house, with the caveat that I use an Apple Watch for direction or if someone really needs to get a hold of me. I find it helps me remain present, and have been enjoying it thus far.

Conor,
Author of Investment Talk
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I tried second life when it first came out I was probably 12 or so. Issue was the dialup internet 😂😂 that and the people going around just screaming racism and insults at others.

Not much has changed really!
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Twitter's $44B Deal on Hold
Elon Musk announced earlier today that his proposed $44B acquisition of Twitter $TWTR will be put on hold "pending details supporting calculation that spam/fake accounts do indeed represent less than 5% of users".

The stock is currently trading ~20% down in the pre-market, for ~$35 per share.

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SBUX: "We're Playing the Long Game"
Starbucks $SBUX continues to demonstrate a robust recovery in its domestic territory, with International (Ex-China) playing catch up. The focal point of Q2 earnings, however, was the temporal deterioration of the China business. Plagued so badly by zero-covid policy closures, the contagion from the China arm of the business resulted in Starbucks withdrawing guidance for the remainder of the year. But fear not, the prodigal son has returned for a third stint as CEO. Schultz has long been a catalyst for the Starbucks China expansion, expressing his desire for 5,000 stores in the region by 2021 as far back as 2015, when there were fewer than 1,500 stores. Reaffirming that he believes China’s dismal performance is transitory he would go so far as to suggest he is "convinced Starbucks' business in China will be eventually larger than our business in the U.S."

If we imagine Starbucks is a pizza for a moment, with the thick doughy base being the core business. Sat atop of that base, are toppings like supply chain woes, inflationary cost environment, looming management transition, high employee attrition, and discombobulated global mobility. These are what the observer sees when staring at this pizza… I mean business. All very yummy, but it’s missing something. A sprinkle of je ne sais quoi (gestures pinched fingers). Oh yes, there is a raging union movement still percolating within Starbucks’ most important market. Thankfully, unlike his predecessor, Schultz mustered up the courage to say the word, “union”, in the earnings call. There is a lot going on at the world’s favourite java joint, so I want to stick to the crucial matters at hand today; recovery, china, and the union.

Key Takeaways

• North America is Strong: North America recovering well, with revenues +17%, bolstered by a 5% increase in transactions and a 7% increase in average ticket. Comparable sales were up 12%, and pricing increases were met with minimal attrition and sustained demand.
• China Hurting: Lampooned by China’s zero-covid policy, revenues fell 14%, with average ticket down 4%, transactions down 20%, and a 23% decline in comparable sales. 1/3 of stores remain closed heading into Q3, and company-wide guidance for 22’ has been withdrawn as a result of the uncertainty.

• NFT/Web3 Chatter: Schultz announces some hair-brained ideas to incorporate Web3 and NFTs into Starbucks’ digital and rewards businesses. It will be the “digital third place”, apparently.

• Union: Unionised store count has 10x’d since I last wrote about Starbucks in March, standing at 65 stores. Only 12% of votes resulted in rejection.

• Hefty Reinvestment Cycle Ahead: Starbucks are set to reinvest heavily into store optimisation, wages and benefits, and digital, in an effort to transform the business in the face of changing consumer behaviour. Share repurchases have been axed to free up capital to do so.

Domestic Strength

All things considered, North America is doing relatively well. Churning out $5.45B in revenues (+17%) during the quarter, the region was supported by a 12% growth in comparable sales, a 5% increase in transactions, and a 7% increase in average ticket. Starbucks has raised prices several times over the last year to offset inflationary pressure with “negligible customer attrition”. This is similarly exemplified through the fact that both average ticket and transaction volumes hold strong. Even so, price events were not enough to outpace inflationary expenditure, as demonstrated by the segment’s EBIT margins.

Sitting at 17.1%, down 220bps YoY, there was some lapping of government subsidies that should be taken into consideration, but supply chain costs, investment in labour, and enhanced store partner wages and training costs, are the primary culprits here. With the announcement of further wage increases (likely to combat the union), and the continuation of an inflationary environment, it might be some time before things crawl back to equilibrium.
I chose the title for this memo because Starbucks is seemingly at risk of an impasse after its 50-year history, which Schultz plans to navigate by transforming the business once again. Cold beverages, for instance, is a product category that equates to anywhere between 60% and 75% of total beverage sales in a given quarter. Yet, despite the insatiable demand, Starbucks stores are not optimised for cold beverage output. Naturally, Schultz plans to reinvest in this area, expanding cold beverage station capacity in stores. That’s just one example, but the reality is that Starbucks was once a “third place” for consumers to physically park their posterior and chill for an hour or two and it’s still built for that reality.

Today, increasingly complex cold beverage orders are a larger part of that equation. Mobile Order & Pay, a $4B business in its own right which has grown 4x over the last 5-years, drove over 70% of store volumes in the States alongside an increasing demand for drive-thru. Delivery, another $500M business, is one which has grown 30% YoY as consumers continue to favour Starbucks from their homes or office. Even the way customers engage with Starbucks has changed. With 26.7M active Rewards members in the United States (120M total members), an approximate $11B or so is spent at Starbucks stores each year, from pre-loaded cards.

It comes as no surprise that Starbucks needs to get with the times. Schultz appears to be ready to do just that:

“Given record demand and changes in customer behaviour we are accelerating our store growth plans, primarily adding high-returning drive-thrus, and accelerating renovation programs so we can better meet demand and serve our customers where they are.”

He later remarked that ~90% of all new store openings would be high-returning drive-throughs. So, a multi-year investment cycle which understandably has to take place, but one that is going to cost a pretty penny. This was no doubt on Schultz’s mind during his first action as CEO, to shut down the share repurchase program and preserve liquidity. I had imagined, at the time of the announcement, that this was mostly related to the balance sheet, as Starbucks’ leaves a lot to be desired. This was echoed in the call, but supplemented with a narrative that ROI is stronger when reinvested into new US stores, which are cited to exhibit a ~55% ROI compared to annualised buybacks that sit at a ~10% ROI each year.

Put simply, “investments in our stores - have an outsized return relative to what we could do with buybacks”. As a shareholder, with a time horizon of longer than 2 weeks, I don’t hate this. Sure, EPS will suffer from no share repurchases, but dividends and heavy buybacks are oft signs that the company feels it has no other attractive avenues for reinvestment. To bemoan the assertion that management now feels it has a better way to use that capital is nonsensical.

NFTs

Speaking of nonsensical, I sighed as I listened to Schultz, a 68-year old man, enthuse about NFTs and Web3. More specifically, talks of a “big breakthrough idea” related to the launch of a “unique platform for NFTs” from Adam Brotman, the architect of the Starbucks digital app. If his app design is anything to go by, I am not optimistic about what he does with NFTs. Having long expressed a desire for Starbucks to gamify its app and rewards program, this is not what I had intended. Talks of creating a “digital third place” with the ability to create incremental revenue unto itself as a separate business, feel very 2021 to me.

However, I must admit, that I am eager to see what they will do to rejuvenate the rewards program, whilst remaining sceptical about the means through which they plan to do so.

International Weighed Down by China

The international segment was notably weighed down by the China results. Excluding China, the segment grew comparable sales in double digits and management attests that the segment is recovering well, despite the larger supply chain disruption than the US has faced. In aggregate, the segment generated record revenue of $1.7B (+4% despite China), which would have been +23% excluding China. On a consolidated basis, transactions (-3%), comparable sales (-8%), and average ticket (-5%) all declined, alongside a lofty 520bps decline in international EBIT margins (10.6%), mostly attributable to the same variables that have plagued the domestic EBIT margin. Starbucks International generated just $181M in operating income this quarter for their 17,701 stores (+9%).

China is a Burst Couch

Shrowded by China’s zero-covid policy, 1/3 of stores were closed in Q2 and the rest remained partially open. Results are so poor and the near-term is so uncertain in this region, that company-wide guidance was suspended as the ambiguity looks set to continue. Reports suggest that China intend on continuing its zero-covid policy until October and possibly beyond.

“We expect an even greater impact on our Q3 results due to the timing of the Shanghai lockdown and a further resurgence of the virus in other cities”.

Since the beginning of 2019, Starbucks' Chinese footprint has grown from 3,685 to 5,654 stores (+35%). As ugly a picture the lockdowns paint on revenues and earnings, an optimist might argue that this has the appearance of a tightly wound spring, ready to unwind when things are "normal". In the second quarter of 2022, Chinese revenue fell 14% YoY to $734M, with average ticket down 4% and the volume of transactions down 20%, leading to a 23% decline in comparable-store sales.

As for the number of rewards members in China, cited to be ~18M in Q1’22, there was no update this quarter. These members drive ~75% of sales volume in China, compared to ~50% in North America. After an anaemic 100K net ads in Q1, my suspicion is that 90-day actives in China declined in Q2, understandably, and that management left out the number on purpose. Below is a visualization from 2018 (the furthest back China data goes). Here we can see the strong back-half resurgance that took place in 21’, only for revenues to be plagued by mobility once more in 2022.

*Q2’22 is TTM

The China business is set to look ugly for the remainder of the year, or at least until mobility resumes. For a business that should be generating more than $4B in annualised revenues at its current size, I stand by my assertion that China may one day be a $10B+ revenue business. That said, the fragility of Western brands’ relationship with the CCP is not lost on me. It only takes one policy alteration, one change of heart, or one tariff, for the China growth story to suffer the fate of a communist sledgehammer. As such, China represents one of the handful of facets that make up the Starbucks bull case but is a relatively larger component of the bear case.

The Union
When I first wrote about the union in February, 88 stores had filed to request a union vote. By March, 141 stores had filed and 6 stores had officially unionised. Today, the approximate number of unionised stores is 10x that, at 65 across the country with only ~12% of stores voting no.

Whilst still a fraction of the overall base, the momentum is continuing. In the earnings call, we finally had someone from Starbucks address the topic head-on. In his opening remarks, Schultz would remind listeners that “our values are not and never have been the result of demands or interference from any outside entity”.

He would continue to outline new benefits that would be rolling out to non-union partners this fall. Benefits include; wage hikes, a new partner app, improved tipping functionality, reinvestment in stores, extending training hours from 23 to 40, and the reintroduction of Starbucks’ Black Apron, Coffee Master and Origin Trip programs. Naturally, the SWBU had their own narrative, claiming that Starbucks would be refusing access to said benefits for unionised stores.

This, being contrary to what Schultz actually said, simply remarking that these benefits would not be unilaterally granted to unionised stores because of the mandatory bargaining process that has to take place. They will be offered, at which point the SBWU are obliged to accept or counter.

If the SBWU “demand these modest improvements be given immediately to all workers”, then is that not the ideal outcome for both parties? I foolishly said as much under that tweet and was called every name under the sun by a gang of unionists. Lesson learned. These benefits are no doubt to control the narrative and persuade partners to buck the union. The SBWU would call it “union-busting”, but at the end of the day, are unions not there to ensure benefits like these come to pass?

Equally intriguing, Starbucks has decided to move up their December investor day to September, to show off both their “pipeline of disruptive innovation” and their “coming transformation and reimagination of the Starbucks customer and partner experiences”. I suspect this was also done to get ahead of the curve on the union drive and show off their spangly new benefit plan. All in all, this union isn’t showing signs of retreating anytime soon, but Schultz and the gang are doing everything in their power to halt it. I have spoken before about the ramifications on margins and the fact that a union for Starbucks makes little sense. So, will leave you with the points that Autumn Capital outlined last quarter on the problems with unionising low-skilled service workers

Financials

For the quarter, Starbucks pulled in $7.6B in revenues (+15%), growth which was carried mainly by North America and International Ex-China. EBIT of $949M was down 4% on the year, with margins down 240bps on account of variables already discussed. China is expected to contribute “half of what we typically expect” in EBIT by year’s end, so some notable headwinds there. Earnings, $675M, were up 2.3%. Much of what I wanted to highlight regarding the income statement has already been discussed, but one last anecdote about margins before we move on.

Last year, investors were told that EBIT margins could expand to 18.5% by 2023. Then the macro-environment got choppy, and Starbucks decided to reinvest ~$1B into staff wages and training. We were told this goal would be pushed out to 2024 as a result. This quarter, that LT target was brought up, only to be sidestepped by Ruggeri (CFO). With all of these reinvestment outlays coming, albeit necessary ones, across digital, automation, equipment, remodelling, staff training and wages, I suspect the majority of these expenses are capitalised, but with wages and benefits being included in store operating expenses, it might take some time before sales leverage can erode their margin impact.

Schultz attests that demand is healthy enough to allow that to happen, telling investors to “just wait until we upgrade the system”, remarking that following this reinvestment period, investors are “going to see us recording the kind of store-level economics we have in the past”. I don’t doubt Schultz has the vision and character to pull this off, but he is not going to be here to see that through.

Balance Sheet
With ~$2B in term debt ($1B of which is due in the calendar year) maturing in the next 12 months, Starbucks issued $1.5B in senior notes in February to refinance a portion of their $16B debt balance. $500M of which is due in 2024, with the remainder set to mature in 2032.

Whilst the decision to pause share repurchases was garnished with an ROI narrative, I suspect it had as much to do with Starbucks’ balance sheet weakness. Excluding the value of stored card balances, Starbucks has a cash ratio ($3.9B cash) of just 0.54. Interest is well covered by the company’s EBIT (~7.6x) and the business is a notorious cash flow producer, but with maturities looming, a $1.1B dividend to pay out each quarter, undergoing a reinvestment cycle during an inflationary environment, and the certainty of those cash flows diminishing in regions like China, halting Starbucks’ repurchases feels like the prudent move.

Prior to the announcement, Starbucks had been expected to utilise ~$8B to repurchase more shares through 2023. The move to abandon repurchases was met with a positive response from credit rating agencies. Moody’s (below) would note that they believe Starbucks has the “necessary levers to pull to navigate these operating challenges and the pandemic-induced restrictions in key markets such as China which should subside over time”.

Source: Moody’s (H/T to @ayeshatariq for sharing)

Concluding Remarks

Drawing conclusions on the quarter, and quarters past, it’s evident Starbucks is in a state of transition. So much so, that Schultz attests to be “playing the long game”. As noted, he is not reported to be at Starbucks long enough to see that through. Originally here until the fall, he now commits to staying on to assist the new CEO until early 2023, whilst remaining on the board thereafter. In his closing remarks, he would remark; “I understand what's needed, and I'm back to lead this transformation and committed to seeing it through”. So, either he thinks this can be completed within the year, or he is signalling that he will stay until the job is finished. I don’t quite know, but walking into this role mid-transition is not an easy feat for any new CEO, so I remain cautious of the eventual managerial transition.

Moving on, when is the best time to acquire a business? When the business itself is going through a hard time? Rather, I believe it is when the market recognises that a business is going through a hard time. There are a number of negative sentiments hanging over Starbucks, many of which I have spoken about today. In my opinion, most of them are temporal. China’s situation is uncertain but unlikely indefinite. Starbucks has survived recessions in the past seeing revenue grow in 2008, and fall 6% in 2009, before recovering the following year. Inflation, and macro generally, is something I have no control over, nor do I have any predictive powers. The data that came out yesterday, on May 11th, shows that whilst inflation is still rampant, we might have seen the worst of it, with more than half of the components down MoM.

These things tend to be volatile but inflation could potentially be topping. Caveat: just because expectations are falling, I don’t assume humans are any greater at predicting disinflation than an aardvark is at playing Nocturne in E flat major.

Starbucks is not quite in capitulation mode, but it does trade a pretty discount to its pre-covid valuation in the low $70s. There are certainly cheaper names out there, but at 19x trailing earnings (24x forward earnings) I have been taking small bites of Starbucks once again after I sold the remainder of my stake from my taxable brokerage at $115 on September 21’ and at $93 on Feb 22’.

For context, the sale in September was unloading excess weight from a heavy March 20’ purchase after it had retraced. The remainder was sold on Feb 22’ so that I could place my Starbucks exposure into a second account, one with more of a focus on yield and coffee can style investing (no pun intended).

Thanks for reading.

Conor,
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Good insight on the union issue. I've owned SBUX in the past. The union issue is one thing I'm paying close attention to. Hoping to see an amicable relationship here.
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Starbucks Reaches 65 Unionised Stores
When I first wrote about the union in February, 88 stores had filed to request a union vote. By March, 141 stores had filed and 6 stores had officially unionised. Today, the approximate number of unionised stores is 10x that, at 65 across the country with only ~12% of stores voting no. $SBUX

Whilst still a fraction of the overall base, the momentum is continuing. In the earnings call, we finally had someone from Starbucks address the topic head-on. In his opening remarks, Schultz would remind listeners that “our values are not and never have been the result of demands or interference from any outside entity”. He would continue to outline new benefits that would be rolling out to non-union parts this fall. Benefits include; wage hikes, a new partner app, improved tipping functionality, reinvestment in stores, extending training hours from 23 to 40, and the reintroduction of Starbucks’ Black Apron, Coffee Master and Origin Trip programs.

Naturally, nobody at the SWBU had their own narrative, claiming that Starbucks would be refusing access to said benefits for unionised stores.

This, being contrary to what Schultz actually said, simply remarking that these benefits would not be unilaterally granted to unionised stores because of the mandatory bargaining process that has to take place. They will be offered, at which point the SBWU are obliged to accept or counter.

If the SBWU “demand these modest improvements be given immediately to all workers”, then that is the ideal outcome for Starbucks too? I foolishly said as much under that tweet and was called every name under the sun by a gang of unionists. Lesson learned. These benefits are no doubt to control the narrative and persuade partners to buck the union. The SBWU would call it “union-busting”, but at the end of the day, are unions not there to ensure benefits like these come to pass?

Equally intriguing, Starbucks has decided to move up their December investor day to September, to show off both their “pipeline of disruptive innovation” and their “coming transformation and reimagination of the Starbucks customer and partner experiences”. I suspect this was also done to get ahead of the curve on the union drive and show off their spangly new benefit plan. All in all, this union isn’t showing signs of retreating anytime soon, but Schultz and the gang are doing everything in their power to halt it. I have spoken before about the ramifications on margins and the fact that a union for Starbucks makes little sense. So, will leave you with the points that Autumn Capital outlined last quarter on the problems with unionising low-skilled service workers
post mediapost media
I know $SBUX looks great from a performance perspective. I haven’t heard rumblings from their employees sounding as unhappy as Amazon’s, but I also don’t consume media outside ESPN and CommonStock anymore. I agree that it would probably be a temporary headwind as plenty of companies cooperate with unions. It may stop me from buying right now, but if I was holding, I would continue to do so.
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Starbucks Domestic and the Search for Greater ROI
All things considered, Starbucks' North American segment is doing relatively well. Churning out $5.45B in revenues (+17%) during the quarter, the region was supported by a 12% growth in comparable sales, a 5% increase in transactions, and a 7% increase in average ticket. Starbucks has enacted several price events over the last year to offset inflationary pressure with “negligible customer attrition”. This fact is similarly exemplified through the fact that both average ticket and transaction volumes hold strong. Even so, price events were not enough to outpace inflation, as demonstrated by the segment’s struggling EBIT margins. $SBUX

Sitting at 17.1%, down 220bps YoY, there was some lapping of government subsidies that should be taken into consideration, but supply chain costs, investment in labour, and enhanced store partner wages and training costs, are the primary culprits here. With the announcement of further wage increases (likely to combat the union propaganda), and the continuation of an inflationary environment, it might be some time before things crawl back to equilibrium.

I chose the title for this memo because Starbucks is seemingly at risk of an impasse after its 50-year history, which Schultz plans to navigate by transforming the business once again. Cold beverages, for instance, is a product category that equates to anywhere between 70% and 80% of total beverage sales in a given quarter. Yet, despite the insatiable demand, Starbucks stores are not optimised for cold beverage output. Naturally, Schultz plans to reinvest in this area, expanding cold beverage station capacity in stores. That’s just one example, but the reality is that Starbucks was once a “third place” for consumers to physically park their posterior and chill for an hour or two and it’s still built for that reality.

Today, increasingly complex cold beverage orders are a larger part of that equation. Mobile Order & Pay, a $4B business in its own right which has grown 4x over the last 5-years, drove over 70% of store volumes in the States alongside an increasing demand for drive-thru. Delivery, another $500M business, is one which has grown 30% YoY as consumers continue to favour Starbucks from their homes or office. Even the way customers engage with Starbucks has changed. With 26.7M active Rewards members in the United States (120M total members), an approximate $11B or so is spent at Starbucks stores each year, from pre-loaded cards.

It comes as no surprise that Starbucks needs to get with the times. Schultz appears to be ready to do just that:

“Given record demand and changes in customer behaviour we are accelerating our store growth plans, primarily adding high-returning drive-thrus, and accelerating renovation programs so we can better meet demand and serve our customers where they are.”

He later remarked that ~90% of all new store openings would be high-returning drive-throughs. So, a multi-year investment cycle which understandably has to take place, but one that is going to cost a pretty penny. This was no doubt on Schultz’s mind during his first action as CEO, to shut down the share repurchase program and preserve liquidity. I had imagined, at the time of the announcement, that this was mostly related to the balance sheet, as Starbucks’ leaves a lot to be desired.

This was echoed in the call, but supplemented with a narrative that ROI is stronger when reinvested into US stores, which are cited to exhibit a ~55% ROI compared to annualised buybacks that sit at a ~10% ROI each year. Put simply, “investments in our stores - have an outsized return relative to what we could do with buybacks”. As a shareholder, with a time horizon of longer than 2 weeks, I don’t hate this. Sure, EPS will suffer from no share repurchases, but dividends and heavy buybacks are oft signs that the company feels it has no other attractive avenues for reinvestment. To bemoan the assertion that management now feels it has a better way to use that capital is nonsensical.

NFTs

Speaking of nonsensical, I sighed as I listened to Schultz, a 68-year old man, enthuse about NFTs and Web3. More specifically, talks of a “big breakthrough idea” related to the launch of a “unique platform for NFTs” from Adam Brotman, the architect of the Starbucks digital app. If his app design is anything to go by, I am not optimistic about what he does with NFTs. Having long expressed a desire for Starbucks to gamify its app and rewards program, this is not what I had intended. Talks of creating a “digital third place” with the ability to create incremental revenue unto itself as a separate business, feel very 2021 to me.

However, I must admit, that I am eager to see what they will do to rejuvenate the rewards program, whilst remaining sceptical about the means through which they plan to do so.
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What a write-up. I just started building my $SBUX position in the last week after having it high on my watchlist the last two years. Will take a while to scale in as I just recently started slowly deploying during these conditions.

Have you ever been to a Starbucks Reserve storefront? I’ve been to the one on Michigan Ave in Chicago. Would be interested in seeing those financials in particular, and as a part of their overall bottom line (however marginal).
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Corrections Be Healthy
Being 25 years of age, I find this equally as exciting as I did in March 2020. No idea when it ends, no idea what the stock market will do in the next few days, weeks, months, or quarters, but the stuff on my watchlist is drifting down to attractive prices, after waiting so long. Not rushing in yet.
Most of this year, I have been buying indices, consumer discretionary, stable value-esq stocks, and keeping away from commerce, payments, and major covid beneficiaries as their narratives reset to reality.
Corrections, and bear markets, are never nice, but they are necessary to reset expectations. And as meme-like, as it might be to suggest, in a bear market, forward IRRs also get a healthy reset in moments like these too. Great companies don't suddenly become terrible becomes because their share price is cut in half.
A study has shown the average drawdown from ATHs from 1950 in the S&P 500 is ~13%, roughly where we are now. From 1928 to 2021, in 59 of those 94 years, there was a double-digit drawdown during the year. 58% of the time, when a double-digit drawdown occurred in a year, investors ended the year with a gain. 40% of the time, the gain was double digits by the year’s end. I'm not suggesting that happens this year, but this stuff is par for the course.
Caveat, I say this with a ~6% cash position that is growing as I continue to build cash at a greater rate that I reinvest. Don't doubt that changes at some point in the future.
I might be the only nerd that actually read a book before I started investing; but Warren Buffet was my primary mentor. He had me absolutely ecstatic waiting on a market crash. I was so excited in March of 2020 I took 3 consecutive days off so I could watch the destruction in real time. But when I started investing around 2012, all the 5 year charts were still showing 2008 in the timeline, so I saw how every strong company recovered after the recession. Between Buffet and the obvious evidence of history repeating itself, no time is more fun for me than these, knowing with absolute certainty that it gets better.
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