Don’t Get Excited About Starbucks’ Chinese Expansion Just Yet

Starbucks Corporation (NASDAQ:SBUX) recently announced its plan to accelerate the store openings in China to 1,500 by the end of 2015. The coffee chain currently has 570 outlets in the country. Besides China, Starbucks will also double the number of stores in Korea to 700 by 2016. The stock had gone to as high as $61.60 in mid-April before declining to $56.60 since. We believe the correction was called for as the stock had started to drift away from fundamentals.

Moreover, there are a few factors you need to consider which might prevent the script from going perfectly for Starbucks. Its competitors in the broader market for coffee include McDonald’s (NYSE:MCD), Caribou Coffee (NASDAQ:CBOU) and Dunkin’ Brands (NASDAQ:DNKN).

See full analysis for Starbucks here

A Word of Caution

Starbucks’ overall comparable restaurant sales (or comp sales) growth for its second quarter stood at 7% with the Chinese comp sales jumping 20%. However, the sales during the initial time period (after a particular store is opened) are usually lower than normal and they eventually pick up. So, the tremendous comp sales growth we are witnessing in China at the moment might be a reflection of store sales reaching their normal levels rather than Starbucks performing extraordinarily. As the stores get older and they reach their expected sales, comp sales growth will fall to more realistic levels.

Another factor to consider is the amount spent by an average Chinese customer. Although Starbucks’ menu prices in developing markets are on par with those in the U.S., similar menu prices don’t necessarily translate to similar spend per customer. For example, an average customer in the U.S. might order coffee and muffin whereas their more price sensitive counterparts in China might order only one of the two, hoping to enjoy the Starbucks experience without stretching his/her purchasing power.

Coming to margins, the operating margins in China/Asia Pacific (CAP) is higher than that in Americas region (39.8% vs 19.8%) which is primarily due to a higher mix of franchised stores. Around 40% of its stores in Americas are franchised compared to more than 80% in the CAP region. Franchised stores typically have margins four times those of company-operated stores. Thus, a greater proportion of franchised stores (or licensed stores) will lead to overall higher margins. On the other hand, the absolute value of profits generated by a company-operated store is more likely to be higher than that for a franchised store.

It surely won’t be a walk in the park for Starbucks as Dunkin’ Donuts and Costa Coffee also plan to increase investments in the country in the coming time. Dunkin’ Brands recently made basketball player LeBron James its brand ambassador for Asia with a focus on China and added pork donuts in a bid to customize its menu to appeal to local tastes.

We have a Trefis price estimate of $55 for Starbucks, which we believe incorporates the growth opportunities offered by the international markets and, at the same time, takes into account the problems unique to these markets that Starbucks is likely to encounter.

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