Is Starbucks Looking At A Rough Road Ahead?

For the past three quarters, Starbucks (NYSE:SBUX)is struggling to grow revenues in the U.S. While comparable sales growth slowed down in the first two quarters of this fiscal year due to a congestion caused by its mobile order and pay system, Q3 2017 showed strong growth but it was only due to an increase in ticket size. This indicates that the company did not witness any growth in customer traffic in the U.S. in Q3 2017. Further, Starbucks lowered its EPS (earnings per share) guidance for the current fiscal year and announced that it would be shutting down its mall-based Teavana stores. As the retail landscape changes with customers preferring the convenience of online shopping, mall traffic is witnessing a decline. Starbucks operates several of its stores in prominent malls and it appears that the company is not immune to this changing retail landscape. The company is looking at China and its premium Roastaries as its next growth drivers, however in the short term, given that the company derives a significant percentage of its revenues from the U.S., Starbucks is likely to witness a slower growth trajectory.

 Traffic Vs. Ticket Size

The most significant takeaway from Starbucks’ Q3 2017 earnings was that the company’s comparable sales in the U.S.  grew primarily due to an increase in ticket size and it did not witness any increase in traffic in this quarter. This indicates that Starbucks’ focus on premium gourmet coffee and food is likely to drive its growth in the U.S. as it entices consumers to spend more at its stores. According to our estimates, the average beverage spend per customer visit at a Starbucks’ company owned store is around $6 and this number is likely to increase by nearly 10% by the end of our forecast period.

However, we do not expect any significant increase in the number of daily customers at a Starbucks store in the short term, but we expect this figure to increase in the last three years of our forecast period

In a scenario where customer traffic stagnates at Starbucks at current levels (an average of around 450-460 daily customers per store) a faster growth in beverage spend or food spend can drive revenues for Starbucks. For instance if the average beverage spend per customer visit increases to $8 by the end of our forecast period, there can be a nearly 10% upside to our price estimate.

The company’s innovative products, focus on healthy lunch options, and gourmet coffee options are likely to be the key growth drivers in the U.S. in the coming years.

Growth In China

Starbucks is banking heavily on China for future growth and the company is seeing strong momentum in the region. Revenues in the region are growing by around 20% annually and it witnessed strong comp growth on the back of growing traffic in China. As the company leverages the scale and infrastructure created in the region, it is likely to see significant margin improvement going forward. Starbucks recently announced that it is acquiring the remaining 50% of its East China JV and is committed to open 5,000 stores in Mainland China by 2021. China is likely to remain a key growth driver for Starbucks, however it would take a few years before this region would contribute effectively towards the company’s revenues and profitability.

In the short term, it appears that Starbucks is likely to face a slower revenue growth as it handles the challenges around slowing mall traffic and new customer acquisition. However, we believe the company has an effective long term growth strategy in place with a focus on food, gourmet coffee, and China which are likely to be its key growth drivers.