On the surface, Starbucks’ strategic priorities announced June 20 are positives. Beverage and food innovations emphasizing health and wellness and personalized marketing efforts through the digital platform should benefit comps over time. Store base optimization (including 150 closings in the United States next year and exploring licensing opportunities in certain markets outside the U.S. and China) and reduced selling, general, and administrative expense (by as much as 1 point as a percentage of system sales, compared with 4.5% year to date) are positioned to drive bottom-line improvement. That said, like many investors, we are in the “show me” camp after several quarters of operational missteps and wonder if more significant actions may be required.
Management’s updated outlook–including third-quarter global comps of 1% and a $0.10 reduction in its full-year adjusted EPS range to $2.39-$2.43–isn’t terribly surprising, given the April racial bias incident in Philadelphia and subsequent employee training efforts. Following the second-quarter update, we wrote that 3% full-year global comps were likely a best-case scenario and that other strategic efforts in the works (personalized happy hour, labor deployment) would probably weigh on margins. However, while management said comps trends had improved and are currently running around 3%, we find the decline in China segment comps to approximately flat growth from recent trends in the high single digits troubling, especially with management highlighting underperforming holiday items as one of the key reasons (in addition to Starbucks lacking delivery options and cannibalization from new stores).
While we’re not ready to revisit the brand intangible asset behind our wide moat rating, we find the execution missteps frustrating and plan to reduce our $68 fair value estimate by roughly 5% to account for projected near-term sales weakness, partly tempered by store closings and SG&A reduction plans.