THE HEDGEYE EDGE
We see Starbucks (SBUX) as a company that is still in need of a reset (in spending and thinking), much like their 2008 turnaround. However, hanging their hat on waste management initiatives, labor savings, and the China business, will not get this done.
DIVERSION TACTICS ARE UNSUSTAINABLE
SBUX continues to boast about its Roasteries initiative, and there is no doubt that the early Shanghai results are impressive. It is difficult to see how Roasteries will have a meaningful financial impact on the business long-term. This is a marketing diversion used to elevate the brand, but we ask ourselves, “How much more expensive can this brand get?”
In addition, SBUX’s global Consumer Product Group (CPG) business is continuing to see competition down the aisle, increasing our confidence that the company will be hard-pressed to find meaningful growth.
ROIIC HAS FALLEN OFF A CLIFF!
Return on capital deployed is a focal point of the health of a business, and SBUX’s ROIIC has seen a marked decline. (Currently sitting at a paltry 0.6%.) With operating cash flow down ~8% YoY and capital expenditures expected to rise over 30% from $1.5B in FY18 to ~$2B in FY18, the question of SBUX’s profitability comes to the forefront. With labor costs where they are (and rising), where on the P&L can the company possibly find relief?
Meanwhile, turning to Same Store Sales… 1Q18 consolidated SSS of +2% slowed 50bp sequentially vs. the two-year average, which has slowed by 350bps since 4Q16. A similar trend can be seen with regard to Americas SSS, which came in at +2.0%, a 150bps deceleration on the two-year average, which has slowed by 400bps since 4Q16.
CONCERNS AROUND LEADERSHIP HAVE GROWN
With the annual meeting coming up, we can’t help but think back to a touching moment at the 2017 annual meeting, where Howard Schultz handed Kevin Johnson the key to the Pike Place store, symbolizing an official changing of the guard. Kevin humbly accepted the key, but we think that he just is not the right person for the job. For a Company like this, an operator would be better suited to lead the charge.
Management continues to believe that technological innovation will be the main growth driver going forward, but we do not see this as a viable differentiator. As we have been saying, “technology may be the future, but they still have to get the coffee in the cup,” and Mr. Johnson has failed to do so, thus far.
We remain below consensus expectations, with the gap widening in the out-years. We continue to predict a rocky road ahead for SBUX, with the stock having more than 30% of potential downside.