Editor's Note: Below is a complimentary research note excerpt written earlier this week by Restaurants analyst Howard Penney.
Starbucks (SBUX) is on the Hedgeye Restaurants Best Ideas list as a SHORT.
HEDGEYE OPINION
We can’t remember the last time SBUX management team spoke about and revealed monthly SSS trends in any given quarter. Given how challenging the company’s 2Q18 performance was, and the need to confirm its yearly guidance, we couldn’t help but to think the sudden sales disclosure was to put a good face on a bad situation.
But when we expand the aperture on the company’s performance, it is clear that the overall business is not accelerating. The slowing sales trend is not isolated to the Americas segment…it is a global issue. According to The Founder's Mentality, as a company expands, growth creates complexity and complexity is the silent killer of growth. The SBUX business model is very complex and the company is in the process of removing some complexity from the business model. At the same time, the company is trying to grow the base of heavy users (loyalty members), which accounts for a majority of the SSS growth. This is a delicate balancing act that will take time to unfold. We continue to see risk to SBUX’s financial performance in FY18.
Putting pressure on the company’s growth initiatives, is the global macro environment. In the Americas and Europe, we would point to an increasingly competitive environment, and China is also seeing slowing economic growth. The back-half recovery still being purported by the management team is going to be challenging to accomplish.
We remain confidently SHORT.
THOUGHTS ON THE PRINT
Consolidated SSS came in at +2.0% vs Consensus +1.8%, showing no acceleration in the overall business. On a two-year average basis, same-store sales have slowed by 300bps since 1Q17. In the Americas, SSS was also +2.0% vs. Consensus +1.8%, showing a slowdown of 350bps since 1Q17. With the comps showing no marked acceleration, it is clear that management's initiatives will take time to kick in, if at all. Adding to their sales problems was the margin compression experienced during the quarter as a result of increased food sales, which now represents 22% of U.S. sales (Americas operating margin was 20.0% vs. consensus 21.4%). We would argue that the focus on food is part of what is creating the complexity that is the silent killer of the company's growth rate.
Turning to the China portion of the business, same-store sales came in at +4.0%, showing a sequential slowdown of 50bps on a two-year basis. Despite management’s confidence in the China business, the metrics seems to be telling a different story, as comps have slowed by 150bps since 3Q17, on a two-year average basis.
NOTABLE COMPANY THOUGHTS
“We continue to mindfully evolve a coffee culture in China where the reward will be healthy, long term profitable growth for decades to come. Supporting this view is the fact that per capita coffee consumption in China is only about one half of one cup per person per year compared to roughly 300 or so cups per person per year in the U.S. and even more than that in certain Western European markets,” (Kevin Johnson, CEO)
HEDGEYE – Interesting how the SBUX management team is confident that they can make people drink coffee. If coffee is not a part of the culture, will be hard to force it upon people. Turning the Chinese people into coffee drinkers will take generations not years.
“Operating margin declined 220 basis points to 20%, which we expected this quarter given our strategic decision to invest in partners, higher product cost of goods sold as food growth continues and lower forecasted comp of 2%.” (Rosalind Brewer, COO)
HEDGEYE – The decline in operating margins will continue as they focus on attempting to grow food to 25% of sales and make further investments into their partners.
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