When coffee giant Starbucks Corp. (NASDAQ: SBUX) last reported earnings over the summer, the market was most interested in its comp-store sales growth in U.S. restaurants open more than one year, a measure commonly called comps. It's an important metric, since it reflects the health of the company's biggest, most-profitable segment. Unfortunately, its comps didn't meet the market's expectations, and shares fell 9% on the next trading day. Almost three month later, Starbucks shares are down almost 14%.
With the next report due to land after market close Thursday, there's no doubt Starbucks' U.S. comps will again get lots of attention, and most likely be the tail that wags share-price dog. But they definitely aren't the only thing investors should watch closely.
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Three other things deserve close focus: the company's progress in China; its consumer packaged goods segment; and its progress with three initiatives designed to drive growth inside its stores.
1: What Starbucks is doing to grow U.S. sales
Currently, there are three main tactics Starbucks' is focused on to help drive its comp sales higher:
- Digital flywheel;
- Food innovation;
- Reserve and Roastery expansion.
Starbucks' "digital flywheel" encompasses several things, including its rewards program, prepaid cards, mobile payments, "Mobile Order & Pay," and delivery.
According to management, changes to Starbucks' rewards program started affecting its comps earlier this year, artificially deflating its traffic results as customer order behavior -- primarily order combining to maximize rewards benefits -- changed. For this reason, the company has been breaking apart its comps result to better show how traffic and average ticket are changing in relation to those shifts in customer behavior. Through last quarter, there were 13.3 million active rewards members, up 8% from the year before; their purchases made up around 36% of sales at U.S. company-operated stores.
At the same time, Starbucks has acknowledged that one of the challenges it faces is speeding up order fulfillment in its busiest stores during peak traffic times. This is one reason behind its roll out of Mobile Order & Pay -- an effort to reduce the length of lines in stores while also facilitating faster fulfillment of orders.
The company said on its fiscal third-quarter earnings call in July that 9% of transactions at company-owned U.S. stores were from Mobile Order & Pay, and that it had rolled out "Digital Order Manager" to 1,000 of its busiest Mobile Order & Pay stores. That provides mobile notifications to customers when their orders are ready, and provides Starbucks baristas with a digital system that replaces paper order tickets. The company is slowly rolling out other initiatives to further improve peak time throughput.
Management also continues to prioritize the development of food offerings. That's an area where the company has, quite frankly, struggled for years, including its purchase (and rapid shuttering) of La Boulange bakery. Yet despite few flubs, food has steadily become a bigger part of Starbucks' store results. Last quarter, 21% of its U.S. revenue was from food sales. Also last quarter, the company started testing its "Mercato" fresh food concept in Chicago, and expanded it to Seattle in August when the initial results exceeded management's expectations. The company is also in the early stages of a partnership that will see the products of Italian baker Princi featured in Starbucks' Reserve and Roastery stores.
What Starbucks needs most from its food offerings is not just to give it a new tool for growing sales during its busy hours, but maybe more importantly, during the stores' slowest period: lunch. This is why, despite multiple missteps, it's important to see the company continue to seek a winning food strategy -- especially one that offers more entree, salad, and sandwich choices that could bring in customers when its stores are quieter.
Starbucks is also in the early stages of rolling out its high-end Roasteries, a few dozen of which locations are expected to be opened in the long term, as well as around 1,000 Reserve stores, and adding Reserve coffee bars in around 20% of its global stores. That would give the company more than 8,000 premium coffee bars and stand-alone locations by 2021, based on its goal of having 37,000 stores open by then. This initiative is being led by Howard Schultz, who stepped down as CEO last year but remains chairman, and actively involved.
2: How the China growth strategy is working
If there was any one piece of news that was under-reported last quarter when Starbucks announced earnings, it was the company's $1.3 billion deal to buy out its franchise partners in mainland China, and take over operations of all its stores in the market, which delivered comps growth of 7% last quarter, with 5% of that growth an increase in transactions.
The key reason why the company has taken the step to operate all its mainland China locations is simple: Management expects that in the long term, China will become its biggest market, eclipsing the U.S.. At the end of 2016, the company had around 2,500 locations in China, and is on track to close out 2017 with 3,000 or more. It currently plans to open at least 500 new stores in China each year.
China is also a big growth market for Starbucks' consumer packaged products such as bottled beverages sold at other retailers, with a joint venture announced in 2016 having expanded the distribution of these products to more than 100,000 locations around the country.
3: A tiny segment that delivers powerful profits
Starbucks' channel development business doesn't get a lot of press, but it's critically important to the company's bottom line. This segment, which includes its single-serve, packaged coffee, bottled beverages, and a few other ways you can enjoy Starbucks products without visiting a Starbucks store, only generated $479 million in sales, less than 9% of the company's total.
But it contributed $210 million in operating income -- about 20% of the company's total, on 44% operating margin, more than double the company's consolidated result. In all, channel development increased sales by 9% and operating income by 12%. A recent deal with AB InBev to produce and distribute bottled teas, as well as expanded distribution of its popular K-Cup and Nespresso pods, are set to continue driving growth in this powerful source of profits.
Looking ahead: Keep an eye on these important parts of the business
When Starbucks reports on Nov. 2, investors would be well advised to continue keeping an eye on the U.S. comps result. The keys to boosting that will likely be the degree to which it can continue improving throughput during its peak traffic periods, its ability to leverage food to bring in traffic during of-peak times, and its ability to execute on a high-end coffee experience, particularly without disrupting what works in its existing store format. But for long-term investors, management's ability to continue developing its footprint in China may be just as critical. Furthermore, channel development remains a mighty-mite business generating outsize profits that pay for a lot of the company's other investments.
Watching the numbers -- as well as what management has to say -- regarding these key factors will go a long way toward allowing you to understanding the business, its prospects, and how well management is executing on its growth strategy.
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