Starbucks Doubling Down On Delivery In The Face Of Competition In China

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SBUX: Starbucks logo
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Starbucks

Starbucks (NASDAQ: SBUX) has pinned its hopes of long-term growth on China, as a result of a significant increase expected in the per-capita coffee consumption. The coffee giant remains on track to add 600 net new stores per year and to achieve its goal of 6,000 stores in 230 cities across Mainland China by the end of fiscal 2022. However, the sales growth has slowed down in the region, with negative comps growth and just a 1% improvement reported in the third and fourth quarters (three months ended June and September 2018) respectively.

According to Euromonitor, Starbucks commands a whopping 58.6% market share in China. Despite this, there is a new upstart on the block. Luckin Coffee, officially launched in January, has been aggressively expanding in China, and has already opened 1,500 stores across 21 cities. Its popularity is based on its more affordable pricing, its promotional strategy, and a focus on delivery. Consequently, it does not come as much of a surprise that Starbucks is now concentrating on introducing such services in its own stores.

We have a $66 price estimate for Starbucks, which is in-line with the current market price. The charts have been made using our new, interactive platform. You can click here for our interactive dashboard on Estimating Starbucks’ Fair Price to modify different drivers, and see their impact on the EPS and price estimate for Starbucks.

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Significant Growth Potential In China

China remains a long-term growth driver for Starbucks, as its GDP, projected to exceed $15 trillion by 2021 from $11 trillion in 2014, is expected to fuel a massive increase in its middle class. Moreover, the per capita coffee consumption in China is about one-half of one cup per person per year compared to approximately 300 cups per person per year in the U.S. While consumption levels in China may never be able to match those in the U.S., even attaining a small fraction of it will benefit the company immensely. The company is also focusing on its ready-to-drink (RTD) business through its partnership with Tingyi, which is expected to expand to over 400 major Chinese cities across more than 125,000 premium points of distribution.

Increasing Popularity Of Luckin

Just 11 months after its official launch, Luckin has grown to over 1,500 stores, with plans to expand to roughly 2,000 by the end of the year. This aggressive expansion comes on the back of an investment of $200 million in a Series A financing round in July, which valued the company at US$1 billion. Luckin took advantage of the long queues at the various Starbucks stores by focusing on its mobile app and concentrating on delivery. Orders are paid for using WeChat payments or the company’s own coffee wallet, making it appealing to young consumers in China. Roughly half of the company’s locations are pickup only, and through its app and delivery channels, the company guarantees to have a cup of coffee in a customer’s hands in less than 30 minutes, with the average time being 18 minutes. Luckin’s average cup of coffee is also about 30% cheaper than that of Starbucks, and the company has been following a heavy discounting strategy to attract more customers.

Starbucks Expanding Delivery In China

Starbucks started piloting delivery in Shanghai and Beijing in the fall in partnership with Alibaba, likely a result of the competition from Luckin. Within just two months, the delivery was expanded to all its stores in Shanghai, Beijing, and 11 other cities in China, with an intention to extend it to 2,000 stores by the end of FY 2019 (year ended September 2019). The company’s collaboration with the Alibaba group will ensure a seamless digital experience across Starbucks and the Alibaba platforms, including Ele.me, Hema, Tmall, Taobao, and Alipay.

There are a number of significant gains to Starbucks from the expansion of its delivery initiative. While convenience-oriented millennials are driving the restaurant delivery market, which is likely to grow steadily over the next few years, the coffee giant can also benefit by customers ordering home delivery in the evenings and nights. A bulk of the company’s revenues comes from breakfast and lunch, and if delivery orders pick up in the evenings, this can drive additional revenues for the company. Further, this strategy can help to hold off the threat posed by Luckin, and ensure Starbucks’ plans of tripling its revenues and doubling its operating income in the country over the next five years (as compared to FY 2017) remain intact.

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