Starbucks, already the world’s largest coffeehouse chain has arguably capped out on growth – or at least top line growth. Any contradictory opinions would have been smashed last week, when the company reported its worst quarterly same store sales performance in more than five years.
For the fiscal third quarter 2016 (April to June) the company posted revenue of $5.24 billion, below analysts’ expectations of $5.33 billion. Starbucks’ most closely watched metric – same store sales – increased 4% for the quarter, down from 8% posted last year, and under the 5% benchmark that the coffee giant has been able to hit consecutively for at least the last 25 quarters.
Notably, none of the company’s major operating regions were able to rescue it. Same store sales growth in the Americas - a traditional stronghold and the primary market for Starbucks posted a 3% uptick, less than half of what analysts had expected.
Terming the Americas performance as an “anomaly,” company CEO Howard Schultz in the post-earnings conference call said he expects top line growth from the region to rebound past the all-important 5% mark as recently launched “powerful initiatives” yield results.
Powerful Initiatives
Mr. Schultz would argue Starbucks is very much at the center of a critical transition toward a more premium market where it can stay differentiated from an increasing number of competitors.
On Monday, management said it plans to setup more than 500 stores offering only the premium rare coffee blends supplied by multiple new high-end roasteries.
The move makes sense on paper, as one of the most touted obstacles for the company’s growth has been emerging competition from players such as Dunkin Brands Group.
Dunkin Brands also recently reported dismal quarterly earnings, in part because of its quest to chase Starbucks, some analysts say. Other more traditional fast food players such as McDonald’s and Burger King have also been moving into coffee, which puts more pressure on market leader Starbucks.
In a market where coffee drinkers are increasingly divided between casual strollers ready to stop at any coffee café and high-end fanatics hunting down distinct and rare coffee drinking experiences, Starbucks is perhaps headed in the right direction.
Contradictory Initiatives
The trouble is, that some of Starbucks’ other measures are driving away customers fast. Most notably, the company’s recent revamp of its popular loyalty program which is now based on total spending rather than frequency of visits at Starbucks stores has not been welcomed by many of its most loyal customers.
While the company said it grew its American loyalty program subscriptions 18% year-over-year to 12.3 million active members in the third quarter, the CEO clearly labeled the new loyalty program structure as a key reason for lower top line numbers in the quarter.
For the full year, Starbucks said it expects sales growth to rise by mid-single digit percentages. In the past the company had been touting higher annual sales growth benchmarks.
Also, in line with the company’s summer price hikes that have come to be expected, rates have again been raised on some of its mainstream and popular beverages this year, which the company projects should increase the average transaction size by 1%.
While that seems like a marginal price increment, it could be a problem when one factors in the closing gap between Starbucks and its competitors, which should make switching between a Starbucks cup with say a Dunkin coffee cup all that much easier.
But then again, Starbucks is probably not too keen on retaining the casual coffee drinker anyway. That would explain the higher price points as well the policy to base the loyalty program on potentially larger future orders.
The strategy is a sort of a gamble and is two-pronged. It sacrifices some in-store traffic and checks in the short term for longer term gains in the average check size. This can result in a a smaller but more loyal base of true coffee enthusiasts at the cost of a larger mass market, comprising largely casual coffee drinkers.
But until these longer term benefits materialize – if they do – this strategy may likely translate into more dismal earnings and this is perhaps already indicated via the cropped full-year sales target. Can investors stay loyal through the rough ride?
Starbucks shares are already down 4.7% so far this year, trailing the broader market’s 5.2% gain. I expect the stock to continue to take frequent dips as more negative Wall Street commentary and shaky financials get priced in over the remainder of the year.
I am also excited about a renewed vision and strategy at the world’s largest coffeehouse chain but not enough to be hurrying off to buy the stock just yet.
By: Ghous Zaman
