If you were to sum up what Mr. Market will be paying the most attention to next week, when Starbucks Corporation (NASDAQ: SBUX) reports third-quarter earnings, it's comps. That is, comparable sales, which measures revenue at Starbucks coffee shops that have been open for at least 13 months. And for good reason, since after years and years of steadily delivering 5%-plus comps growth, the caffeinated behemoth has seen this important measure of growth slip in recent quarters.
Even more concerning to many investors, Starbucks' comps transaction count -- a proxy for traffic in its restaurants -- was down on a consolidated basis and in the Americas last quarter. This showing has certainly affected Starbucks' stock price, which is more or less where it was one year ago, and down 10% since early June. But at the same time, Starbucks continues to deliver incredible top- and bottom-line results, reporting record profits and sales every quarter for the past several years, as many of the company's growth initiatives pay off.
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Let's take a closer look at what to expect when Starbucks reports earnings on July 27. Comps are important, but there's a lot more investors need to pay attention to.
But first, comps
Starbucks' comps as reported measure only company-owned stores. That's important for a couple of reasons. First, the company's expansion in China/Asia-Pacific is heavily tied to licensees, which own about 75% of the new Starbucks stores opened each year in Asia, while the company has been steadily selling its Europe, Middle East, and Africa (EMEA) stores to licensees over the past few years. So comps offer a limited view of how Starbucks' stores are performing, especially in market such as China, where licensees operate most stores.
Comps growth has slowed over the past three quarters, starting with Q3 of 2016, when U.S. comps growth dropped from 7% year over year and 9% sequentially, to "only" 4%. Since then, it has slipped more, falling to 3% growth on a consolidated basis last quarter.
Furthermore, transactions have fallen in the most recent quarters. On the Q3 2016 earnings call, then-CEO (and still chairman) Howard Schultz said that result was almost entirely related to changes made to the Starbucks Rewards loyalty program. Declining transactions, he said, were caused not by fewer customers in stores, but by changes in the rewards program that led to more order consolidation so that people could maximize the program's benefits. Schultz also said management has "a clear line of sight to returning our business to historic levels of comps growth."
In the two quarters since, that "line of sight" hasn't exactly translated to a resurgence in comps growth, though there was a hint in last quarter's earnings that the trend may have finally started reversing. The company said U.S. comps grew 4% in March and "further accelerated" in April, the first month of the upcoming quarter.
It's not just North America that's faced weakening comps growth. China/Asia-Pacific comps grew 3% last quarter, but the vast majority of that performance was driven by China, which reported 7% comps growth on a strong 6% surge in transactions. The EMEA segment reported a 1% comps decline.
A year has passed since management blamed changes in the rewards program and the timing of a big marketing promotion on the weakened comps, and it's likely that this theme will remain a key point of conversation among management and analysts on the earnings call.
Several things to pay attention to, related to comps, when the company reports include:
- The "digital flywheel," which includes initiatives such as mobile order and pay, delivery, and other steps to drive higher throughput and cut down on wait times during peak hours.
- Food and beverage innovations to grow sales outside the traditional morning hours.
- An update on the Starbucks Rewards program.
Asian expansion remains a major priority
At the end of last quarter, Starbucks had 26,161 stores, having opened 2,271 new stores over the past year. Of that total, 1,015 were opened in the China/Asia-Pacific region, nearly 45% of the total. And this isn't a short-term growth spurt, either, with Asia -- especially China -- on track to become the company's largest segment in the future. As CEO Kevin Johnson said on the last earnings call, Starbucks opens a new store in China alone about every 15 hours and expects this rate of growth "to continue for decades to come."
Starbucks ended the third quarter with over 2,600 Chinese stores, but it plans to reach 5,000 stores by 2021. That would require the company to open an average of nearly 700 new stores in China yearly to reach that near-term goal. The big driver here is China's burgeoning middle class. Most estimates are that China's middle-class population will surpass 600 million members by 2022, roughly double the 300 million-plus in 2015.
Just as with comps, expect a lot of detail on the company's execution of its expansion plans in Asia, particularly China.
Growth beyond the Starbucks store
Starbucks' products are also found in other retail outlets. Whether it's bagged coffee in your local grocery store, a bottled Frappuccino in a convenience store, or the coffee served on your airline flight, these products account for a measurable portion of revenues and an outsize piece of profits. Last quarter, the company's "channel development" segment reported 8.7% of total sales but 21% of the company's total operating income.
And Starbucks is expecting this segment to keep getting bigger. In the U.S., its market share of K-Cup and roast/ground coffee grew 1 point last quarter, while the company's partnerships with beverage giants PepsiCo and Anheuser-Bush InBev to distribute and sell bottled and canned coffee and tea beverages are both performing well. The company also recently launched Nespresso-compatible pods in Europe, and so far it has taken significant market share.
China is also a key area of growth for Starbucks' packaged beverages, with a recent partnership expanding distribution of its bottled beverages to over 30,000 retail outlets. It has tripled its ready-to-drink sales in the country.
At less than 10% of sales, this segment may be a small revenue generator, but with operating income approaching one-quarter of the company's total, strategic expansion of this segment generates a lot of profit for the company. Keep an eye on how well the company's expansion plans are working here.
Looking ahead: continued investment in growth
When Starbucks last reported, management did cut back its guidance for full-year profits slightly, but not because of expectations of slowing growth or weak sales. The reason for the cut is tied to plans to accelerate spending to grow its Roastery Reserve stores and Princi food business, and to expand its digital capabilities.
The company's guidance for the third quarter includes an earnings range of $0.54-$0.55 per share, roughly 5%-8% higher than in last year's third quarter. That performance would be a step backward after steadily delivering double-digit earnings growth for some time now, but management's commitment to accelerating the Roastery Reserve expansion under Schultz, and investing in the "digital flywheel," are priorities that the company expects will pay off.
With history as our guide, the odds are in the company's favor that it, indeed, will.
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