Industry News | April 28, 2017 | By Danny Klein | QSR Exclusive Brief

Is The End Near for Starbucks' Teavana Experiment?

In-store, Teavana is doing just fine. But in malls? That's a different story. Starbucks
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Could Starbucks soon cut ties with its Teavana mall stores? During a conference call Thursday to review the coffee giant’s second-quarter earnings, president and CEO Kevin Johnson brought up the subject at the tail end of one of his statements.

Overall, comparable store sales ticked up 3 percent in the U.S., missing Wall Street estimates of 3.7 percent. The company also posted revenue of $5.3 billion, which fell short of the $5.42 billion forecasts. Earnings per share grew 15 percent to 45 cents in line with expectations. Starbucks lowered its full-year outlook to $2.08—$2.12 a share from $2.12—2.14 a share. One of the main culprits? Disappointing Teavana results.

“… while the Teavana brand continues to be highly accretive to our tea business in Starbucks stores and is now being further leveraged with the introduction of Teavana branded ready-to-drink tea sold into CPG channels, many of our mall-based Teavana stores are continuing to have a negative impact on our overall result. We have launched a review process and intend to take clear action to improve the performance of our Teavana mall store portfolio,” Johnson said in the call.

What this “review process” entails will be an interesting story to follow. Starbucks’ 2012 acquisition of Teavana for $620 million was the largest in the company’s history. This is strictly a retail issue, Starbucks noted, as the product sold just fine at company stores. Internationally, Scott Harlan Maw, Starbucks executive vice president and chief financial officer, said Teavana sales are up 40 percent in Japan and China. Starbucks also began shipping Teavana ready-to-drink teas in February. Harlan Maw said the four flavors, distributed in partnership with Anheuser-Busch InBev, already rank in the top ten in the premium single serve ready-to-drink category in Starbucks’ active markets.

READ MORE: How Starbucks plan to fix its ultra-popular mobile ordering business.

But, again, the mall stores are crawling. “We currently operate approximately 350 Teavana mall stores and as Kevin mentioned over the last several years many mall based retailers have been adversely impacted by reduced foot traffic, resulting from the accelerating shift of consumer behavior away from brick and mortar retail and changes in consumer retail activity overall,” Harlan Maw said. “Because Starbucks is a customer destination, profitability in our Starbucks mall store has largely been unaffected. But our Teavana mall stores have not been immune with many reporting negative comps and operating losses for some time.”

He added that Starbucks has invested in new store designs and improved merchandising. The results just aren’t there, however. “… the rate of the decline coming through last holiday and into Q2 is worse than we had forecast and we are expecting further declines at a number of at-risk Teavana mall stores,” he said. “Since the Teavana acquisition, we have recorded impairment charges and closed mall stores from time to time, but given these recent performance challenges, we recorded a larger impairment charge in Q2 related to certain of these assets.”

That impairment charge drove a 12 percent increase in all-other segments in regards to store operating expenses, he said. Starbucks is “currently evaluating strategic options for the at-risk portion of the Teavana mall store portfolio and will update you over the coming quarters as we set our course of action. It is important to note that we do have a meaningful subset of profitable Teavana mall stores.”

That sounds a bit ominous, although he soon added that this isn’t the first strategic review Starbucks has conducted, and that the goal remains to strengthen the portfolio and increase profits. Overall, Teavana sales in Starbucks stores grew by nearly 10 percent in the second quarter and has “driven a point of comp in the U.S. in virtually every quarter since we launched the brand in our Starbucks stores about three years ago. That's the investment case for Teavana, and the Teavana business remains very much intact,” Harlan Maw said.

Howard Schultz, Starbucks’ former CEO who is now serving as executive chairman, sized Teavana up by reminding investors of its, well, size. “We've got issues with Teavana, but that basically are diminutives when you look at the size and scale of Starbucks revenue and earnings power. We have the largest most important market in the world where we are already the leader with 2,600 stores and one opening up every day and our brand affinity second to none, and that's China. We have a national and global footprint now of over 26,000 stores, 90 million customers a week and still recognized as one of the most respected and recognized brands in the world,” he said.

Johnson began the call by referencing a Wall Street Journal article that stated more retail stores have closed in the first quarter of calendar year 2017 than in all of 2016, and “that more retail stores are expected to close in the U.S. this year than closed in any year during the Great Recession that began in 2008.”

There’s no question Johnson’s first earnings call as Starbucks’ CEO comes during an interesting time for the brand. Shares of Starbucks were down to 4.6 percent ($58.50) in pre-market trading on Friday as traders digested the company’s report and its plans for the challenging future.

Starbucks appreciated a 4 percent increase in average ticket in the second quarter along with a 2 percent decrease in transactions in the U.S. In China, comp store sales grew 7 percent accompanied by a 6 percent increase in transactions.

The real issue being, then, Starbucks’ plan to reenergize its U.S. business. Starbucks has reported single-digit revenue growth in four of the last five quarters.

One path, which the company has been travelling down for some time, is its Starbucks Rewards program and mobile payment platforms.

The rewards program represented 36 percent of U.S. company-operated sales in the quarter, with mobile payment reaching 29 percent of transactions and mobile order and pay growing to 8 percent of transactions. Active membership in Starbucks Rewards grew 11 percent year-over-year to 13.3 million members. There are now 26,161 total stores in 75 countries following the opening of 427 net new stores in the quarter.

Mobile order and pay has been a work in progress for Starbucks.

“You will recall that in Q1, we highlighted that 1,200 of our busiest U.S. company operated stores were experiencing 20 percent or more of their peak transactions coming from Mobile Order & Pay,” he said. “The rapid adoption of Mobile Order & Pay and resulting demand increase was causing throughput challenges at peak in these stores. By the end of Q2, approximately 1,800 of our U.S. company operated stores were experiencing 20 percent or more of peak transactions from Mobile Order & Pay. Steps we have taken since the beginning of the calendar year to increase throughput have enabled to us to better and more efficiently handle increased demand from both Mobile Order & Pay and non-Mobile Order & Pay customers at peak. And we saw measurable progress in peak transaction throughput in Q2, as compared to Q1, in these busiest stores.”

“As we enter Q3, Mobile Order & Pay continues to be a powerful driver of comp, revenue, and attach.”

Investments in the Roastery Reserve and Princi businesses tied into the added costs, with Starbucks saying the moves are designed to sustain growth long term. A second Roastery is coming to Shanghai later this year and other units are currently under construction in New York, Milan, Tokyo, and Chicago, which was just recently announced.

“And one thing about the roastery that I should point out is that as strong as the roastery has been in Seattle, 20 percent comps, being profitable, it's not a city in which we can have the global halo that New York, Shanghai, Tokyo, Milan, and Chicago will have when those roasteries open,” Schultz said. “It's a roastery that basically is catering to mostly local Seattle people and West Coast tourists. Wait till these roasteries open in these other markets. It's going to change the company.”