Part V: Starbucks Growing Dependence On China The Main Factor To Drive Future Growth

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We have previously discussed four of the five key growth drivers Starbucks is focusing on as a part of its five-year plan to achieve 10% y-o-y revenue growth and 15%-20% earnings growth. ( Will Starbucks’ Stock Fly Higher In 2017 On The Back Of Its Digital Flywheel Strategy?, Part II: Starbucks’ Consumer Packaged Goods Segment To Contribute More Towards Revenues, Part III: Starbucks To Expand And Innovate Its Store Portfolio To Accelerate Growth, and Part IV: Product Innovation And Brand Elevation To Drive Sales At Starbucks )

The fifth and one of the most important drivers for growth at Starbucks is the burgeoning demand for coffee in China. China is the brightest star of the Starbucks growth story. The company has almost 2,500 stores in over 110 cities in China, and continues to open more than one store per day. China outshone the other regions in almost every quarter, by posting growth in comparable sales, supported by increased traffic. Starbucks sees over 5 million transactions per week in its Chinese stores. Further, the company has been able to improve its average unit volumes in the region from $618,000 in FY 2013, to $671,000 in FY 2016.

One of the major reasons behind Starbucks success in China is is its commitment towards delivering what customers want. Instead of trying to pitch the U.S. bestsellers in China, it came up with new and innovative products, such as green-tea flavored coffee, which holds appeal for the country’s masses. Secondly, rather than pushing take-out orders, which account for the majority of American sales, Starbucks adapted to local consumer wants and promoted dine-in service. The store designs are influenced by Chinese architecture in order to appeal to the masses.

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And finally, its has managed to keep attrition among employees low by investing in them through programs like student loans and subsidized accommodation.

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To reinforce China’s growth potential, Starbucks has plans to open up 2,500 new stores in the region in the next five years, and doubling its footprint to 200 cities. Consequently, the management expects the revenue and operating income to triple. Although the plans may seem ambitious, we believe that Starbucks has the capability to achieve these targets. Take into consideration the following statistics:

  • China’s middle class is rapidly growing. It has already increased exponentially from 66 million in 2005 to 300 million in 2015. From here on, it is expected to double to 600 million by 2022. Further, the Chinese population is expected to grow to over 1.4 billion (forecast according to the Economist Intelligence Unit) in 2030, and its low income bracket is forecast to fall to only 11% of the total population. This will result in 89% of the population being able to afford a regular cup of coffee from Starbucks, as opposed to approximately 60% right now.

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  • According to the data from Roland Berger, Starbucks dominates the Chinese coffee market with an impressive 60% share, while McDonald’s and Costa only make for 13% and 11% of the total. This, in confluence with the 15% y-o-y growth expected in specialty coffee in China, could bode really well for the company.

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  • China accounts for over 10 million of the 19 million My Starbucks Reward members in China and Asia Pacific (CAP). The growth rate of reward members in the period between FY 2013 and FY 2016 has been a phenomenal 63% y-o-y. This gives us an indication towards the popularity of Starbucks in China.

  • The demand for consumer goods in China is expected to rise at an annualized rate of 7% y-o-y in the next four years, according to McKinsey. Consequently, we can expect the demand for Starbucks products (in-store, packaged, and premium roastery products) in the region to increase.

Keeping the growth potential in mind, Starbucks has entered a number of partnerships. One such partnership is with Alibaba, to launch a store on the Chinese company’s Tmall e-commerce website. The partnership will allow Starbucks to reach a much broader audience than ever before. Another interesting partnership is with Tencent, a provider of internet value-added services, to create a new social gifting feature on WeChat, which has 846 million global active monthly users. Furthermore, customers will be able to use WeChat Pay to make purchases across all Starbucks stores.

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The only downside to its potential growth in China is the uncertainty of policies under the Trump administration and the strength in the U.S. dollar. The foreign exchange headwinds are expected to erode the company’s sales on conversion from yen to dollars. Decreasing revenues from a negative currency correlation and increasing costs may weigh heavily on Starbucks Chinese operations. Another factor could be China’s decision to restrict Starbucks to expand further in the country if tensions continue to escalate with the U.S. However, these are likely short term factors and can be overcome.

USD to CNY (Jan’16-Dec’16)

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Have more questions on Starbucks? See the links below.

Notes:

1) The purpose of these analyses is to help readers focus on a few important things. We hope such lean communication sparks thinking, and encourages readers to comment and ask questions on the comment section, or email content@trefis.com
2) Figures mentioned are approximate values to help our readers remember the key concepts more intuitively. For precise figures, please refer to our complete analysis for Starbucks

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