Starbucks: Schultz to the rescue... again?

Starbucks is feeling the heat but Howard Schultz has been here before. 

He’s just started his third stint as CEO and his second time returning to the company to execute a turnaround strategy. 

Schultz last parachuted himself back into the driver’s seat in 2008. With the world reeling from the financial crisis, Starbucks needed some swift action. 

The big plan back then was to get the US business back in shape and expand globally. 

And to be fair that strategy has worked pretty well. Starbucks successfully expanded to China, now the group’s second largest market with over 5,000 stores. No mean feat given the nation is famed for tea, coffee’s sworn enemy.

‍

But then came the pandemic. And while disruption was to be expected, two years in and China’s zero Covid policy continues to weigh on performance. 

Over the first four months of 2022 (Q2 for Starbucks), North America same store sales were up 12%, underpinned by more coffees being sold at higher prices. The international business, however, paints a different picture. 

Same store sales were down 8%, primarily driven by the drop-off in China, where sales are down 23%. At the end of Q2, a third of Chinese Starbucks were closed, words we haven’t written in a while. 

With no sign of this open/closed cycle letting up anytime soon, perhaps it’s no surprise that Schultz is back. 

His plan? Get the US back in shape, expand globally (deja vu?) and wait and see about China.

‍‍

Mochas in the metaverse?

While titled Web 3.0 and focused on improving the digital proposition, Starbucks strategy for now appears resolutely in the land of Web 2.0.  

Schultz thinks Starbucks is inadequately equipped to deal with the post-pandemic customer and subsequent demand boom. And he’s earmarked millions in investments, paused share buybacks and is issuing debt (a $1.5bn bond this quarter) to get there. 

Going digital and addressing store efficiency is the headline objective, with Drive-thru and Mobile Order & Pay now accounting for over 70% of US sales volumes. Delivery is growing rapidly too but Starbucks (says Schultz) is still looking too much like its 2018 self to cope. 

McDonald’s made these moves a few years ago and so far ordering our nuggets on a human-sized screen or a mobile and being widely available for delivery is working well for them. 

If Starbucks can pull off a similar feat, while investors will need to be prepared for margin pressure and potentially less generous shareholder returns in the near term, a few years of hunkering down and improving the proposition could make all the difference.

‍

Coffee prices, costs and Covid 

Sipping the Schultz kool aid is the easy bit though. While he has a proven record of delivery, there’s a lot that’s still out of his control. 

Booming commodity prices haven’t left coffee behind. 

Wholesale coffee prices have roughly doubled since 2020 edging up to $2.21/lbs and could well go beyond the record price of $3/lbs set in 2011.

‍

Past performance is not a reliable indicator of future returns.

‍

Starbucks says it’s been able to pass this on to customers so far, thanks to a loyal customer base and “record” demand. But operating margins tell a slightly less triumphant story, dropping a few percentage points this quarter. 

The real challenge is that it’s not just the price of coffee Starbucks has to contend with. Most costs have increased by record amounts and Covid is a storm cloud that still lingers. 

All in all, Schultz has got his work cut out. The opportunity or challenge lies in deciding if this is a turnaround to back.

With a valuation currently around 22x earnings, Starbucks is trading at the bottom of its historic average of 20x - 35x earnings. Suggesting the market has less of a thirst for the stock than it has done. 

That’s still a punchy valuation in many investors’ minds but, given it has been much higher in the past, might reflect a reluctance to believe there is a whole lot of growth ahead of the chain.

But all this shouldn’t necessarily be a turnoff, as we’ve seen with the latest round of US earnings, the market isn’t on board with much at the moment. 

‍

Important Information

‍

This should not be read as personal investment advice and individual investors should make their own decisions or seek independent advice.

When you invest, your capital is at risk. The value of your portfolio, and any income you receive, can go down as well as up and you may get back less than you invest. Past performance is not a reliable indicator of future results.

Freetrade is a trading name of Freetrade Limited, which is a member firm of the London Stock Exchange and is authorised and regulated by the Financial Conduct Authority. Registered in England and Wales (no. 09797821).