Should Starbucks Investors Be Worried About the Company's New Rewards Program?

Image source: Starbucks.

Stock gains of roughly 240% over the past five years and expectations for healthy earnings growth are reflected in Starbucks' forward P/E ratio of 36, and concerns about broader economic trends are prompting appraisal and reappraisal of the long high-performing stock. Amid these concerns, the coffee giant is also catching heat from customers and analysts about changes to its customer rewards system.

The controversial new rewards programsees the company apportioning points per dollar spent, as opposed to the previous system that awarded points based on number of visits. Adding extra juice to the matter, Dunkin' Brands has improved its rewards program in conjunction with a revamped mobile approach and has even taken the opportunity on social media to poke fun at Starbucks' perceived misstep.

Vocally dissatisfied customers and ample media coverage suggest that, to some extent, the dissatisfaction with the new Starbucks rewards program is real, but does the change represent a significant threat to the value proposition of Starbucks stock?

A brewing controversyThe big rewards shift comes at a time when the Seattle coffee giant's ability to deliver strong growth from its more than 24,000 global locations is debated in the context of volatility in China, domestic competition, and concerns that the brand could lose appeal in the event of significantly weakened economic conditions. Evidencing the sentiment that the rewards program could present a meaningful threat to Starbucks, a Deutsche Bank analyst recently issued a downward revision on the stock and cited the new rewards changes amid competing offerings from Dunkin' Donuts as a factor in the downgrade.

With a P/E that's roughly double that of the S&P 500 Index andunknown variables in key growth markets including China, there are valid reasons to take a cautious outlook on Starbucks, but the rewards program might not be as big an issue as initial customer dissatisfaction and the Dunkin' Donuts' marketing push might suggest.

Why the rewards program controversy could be overblownDunkin' Donuts' ribbing of Starbucks and the highlighting of its own ample April rewards offerings is well-timed and supported by a revamped mobile app and membership incentives, including a free beverage of any size for signing up with the program. The rewards push and app overhaul indicates movement on the company's stated desire to drive growth with better promotions, but it's far from a clear sign that the new rewards program will drive Starbucks customers to switch to Dunkin' in significant numbers or be a definitive factor in new customer acquisition. From its coffee and food items to its in-store layout, Starbucks is significantly differentiated from Dunkin' and most other competitors in the space, and the customers visiting Starbucks stores enough to be frequent participants in its rewards programs could prove among the most difficult for competitors to court.

While the switch to the new points-per-dollar system is clearly not universally loved, the promotional steps that Starbucks is taking with its rewards revamp might actually work to speed adoption of the company's mobile app -- a major focus as it seeks to create more personalized connections with its customer base and streamline its store experience with mobile ordering and other features. Like Dunkin', Starbucks revamped its mobile app with the rollout of the new rewards program, and is running a promotion that offers a year-long membership to Starbucks Gold Rewards program to users who make a purchase with Starbucks' app or regular rewards card by May 2. The Gold upgrade might not have the same immediate appeal as a free beverage from Dunkin', but the benefits of easy entry into Starbucks' upper-tier rewards program could win over skeptics with time.

In a worst-case scenario where the new rewards program proves to be a complete miss with customers, Starbucks wouldn't face great barriers in returning to its previous system and could offer extra freebies as a proactive gesture. It seems unlikely that such a move will be necessary, but the option for reversal is there if needed, and expecting Starbucks to deliver a rewards program that satisfies customers is not unreasonable, given the company's brand history.

More pressing issues for Starbucks investorsWhile the possibility of continued issues stemming from the rewards change exists and keeping the brand in top shape is greatly important, Starbucks' stock performance probably hinges on factors that are much bigger and more complex than the rewards controversy.

China is Starbucks' second-largest market, and the company is counting on big growth in the territory, anticipating that the country's middle class will have increased from a 300 million-person base in 2010 to 600 million in 2022. The company currently operates roughly 2,000 stores in mainland China and is targeting 3,400 by 2019, with room for significant further expansion if middle-class growth targets pan out as anticipated.

The company is also expanding its packaged-food strategy across territories, with a partnership with Chinese consumer-goods company Tingyi for a bottled-coffee release later this year and an effort with PepsiCo to scale up bottled distribution in Latin America. If discretionary spending in China and other emerging markets continues to see favorable trends and Starbucks continues to find success with its food and packaged innovations, it has strong growth prospects and the ability to reward continued investor confidence.

The level of strength assumed in those growth propositions relative to Starbucks' valuation should guide investor action, with the new rewards issue representing a more tertiary concern.

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Keith Noonan has no position in any stocks mentioned. The Motley Fool owns shares of and recommends PepsiCo and Starbucks. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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