Starbucks’ mild first-quarter earnings report triggered some warning signs for investors. Bernstein analyst Sara Senatore even downgraded the coffee chain’s stock to market perform from outperform Monday, and trimmed the price target to $64 from $67. After falling late last week in wake of the Thursday report, Starbucks continued to decline slightly and was trading 1 percent lower to $57.30 mid-Monday morning.
Senatore said in her note that Starbucks’ business mix is shifting toward China—just not fast enough to offset slowing U.S. growth. U.S. same-store sales increased 2 percent in the first quarter, while China rose 6 percent. Like many fast-food chains, especially Yum! Brands, the China news is a factor worth appreciating long-term. For example, KFC reports 26 percent of its entire system sales in China. Pizza Hut garners 17 percent. Both of those figures are climbing.
For Starbucks, China boosted revenues 30 percent in Q1, thanks in large part to the $1.3 billion record-setting acquisition of the remaining 50 percent share of its East China business. There’s little doubt Starbucks potential in China is vast.
“Starbucks has cracked the code on China and no western consumer brand is better positioned than Starbucks in China. You have to experience our business in China for yourself to fully appreciate it, but we are much more than simply a coffee retail, as our world-leading financial and operating performance attests,” CEO Kevin Johnson said in a conference call, noting that China’s GDP is expected by many economists to exceed $15 trillion by 2021.
But what about the 14,000 or so U.S. stores? You could argue that 2 percent growth is simply disappointing relative to Starbucks’ robust financial history. Yet the fact this crossed some holiday periods points to a larger issue that has been building: Can Starbucks reignite its traffic stateside, or will the java giant need to shift its strategy to get customers back into stores?
In this past quarter, Starbucks food comps were 2 percent. Core beverage comp, excluding holiday limited offerings, was 1 percent. Together, Johnson said in a conference call that holiday LTO and lobby items had a negative impact of more than 1 point of comp. Explained in a different way, Starbucks’ often buzz-worthy limited-time releases simply didn’t land with the same authority.
Johnson said same-store sales were up 3 percent in the first half of the quarter. As seasonal beverages and merchandise hit stores in mid-November, however, the dollar value of customer transactions fell and the total same-store sales increases dropped to 1 percent. Visits from non-rewards members also slowed down in the second half of the quarter, perhaps pointing again to less-than-effective seasonal releases.
“The decline in transaction comp was primarily driven by two factors. First, while traditionally contributing to Q1 comp growth, our limited time holiday beverages, holiday gift cards, and holiday merchandise available for purchase in our stores' lobby underperformed in Q1, Holiday LTOs and merchandise did not resonate with our customers as planned,” Johnson said. “… We are aggressively rationalizing our merchandise approach in conjunction with the transformation of our lobby strategy going forward.”
What does Starbucks have in mind then? Johnson said the company continues “to reap the benefits of the success of our efforts to increase throughput at peak, specifically, our highest peak volume stores continue to out comp the average for our U.S. portfolio overall with efforts around staffing, technology, and lean principles all yielding measurable results.” This addresses an issue that was prevalent in recent quarters—the fact Starbucks lagged behind some competitors in the convenience arena.
Starbucks has another plan, Johnson said. The chain is taking a more-focused aim at the afternoon daypart. This is being approached via food and beverage innovation.
Culinary wise, Starbucks’ Mercato lunch menu is expected to expand from two to eight markets in fiscal 2018. That’s more of a long-term plan right now than a quick fix.
For drinks, Johnson said new, core launches, not gimmicky short-term boosts, would anchor the business. In January, the company launched its first new espresso in over 40 years with the Blonde offering.
“We believe this roast is appealing to a broad audience seeking a lighter, sweeter espresso experience,” Johnson said.
“We have a big opportunity to leverage our core beverage platforms, particularly in iced coffee, tea, cold brew, and draft beverages, all of which skew toward the afternoon,” he added.
Starbucks said it’s accelerating the rollout of Nitro cold brew from 1,300 stores currently to 2,300 restaurants in the U.S. by the end of 2018. Johnson said the brand has seen about 1 point of additional comp growth in stores offering Nitro cold brew this past year.
“Nitro also provides the foundation for a broader platform of draft beverages that expand beyond coffee to include alternative milks and tea-based Nitro-infused beverages,” Johnson said.
Johnson also noted that Starbucks’ plant-based beverage platform continues to expand, leveraging offerings like almond, coconut, and soymilk alternatives. Tea and Refreshers contributed comp growth this quarter as well. “These beverage platforms also align with our focus on the afternoon occasion,” he said.
There is no surprise that Starbucks also expects to lean on its “digital flywheel,” as Johnson called it, to promote growth. The company has one of the most engaged rewards programs in the country, across any business. Starbucks added 1.4 million Rewards members in the U.S. in Q1, up 11 percent year-over-year, bringing the total to 14.2 million active members. Mobile payment in the U.S. has grown to more than 30 percent of total tender. “The ubiquity of mobile and credit card payment is enabling us to begin an exploration of cashless stores in the U.S.,” Johnson said, referencing the recent opening of a cashless unit in Seattle.
“Through our Rewards program, we continue to drive increases in per-member spend by leveraging personalized offerings and suggested selling to our customers. By expanding capacity at peak, we have now the ability to offer mobile order and pay to our non-Rewards customers and will begin accelerating the ramp up of mobile order and pay to all customers beginning in March,” he added.
An example of this digital push is Starbucks’ upcoming release of a co-branded credit card. The company, in partnership with Chase and Visa, plans to unveil the card in February. Customers will earn stars in an accelerate rate at Starbucks, as well as everywhere else they shop. In April, a co-branded store value card targeted to customers who don’t want or qualify for credit cards will also be unveiled, allowing customers to earn stars wherever Visa is accepted.
Starbucks isn’t content with its Rewards growth, though. In March, it’s launching “a significant marketing initiative” to sign up customers for special offers outside of Starbucks Rewards.
“With only 14 million of the 75 million or so unique customers who visit us each month signed up for Rewards, we have a tremendous opportunity to leverage our new digital technologies to initiate and advance additional direct digital relationships. By the end of the fiscal year, we expect to establish millions of incremental digital customer relationships outside of Starbucks Rewards, giving us an entirely new direct marketing capability to a vast customer audience,” Johnson said.
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