Starbucks: U.S. And China Cast Shadows To Near-Term Outlook
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Summary:
- Starbucks reports declining U.S. and Chinese comp sales, suspends fiscal 2025 outlook due to ongoing challenges, and expects FYQ4 comp sales to decline by 7%.
- U.S. challenges include constrained consumer spending and poor app experience, with comparable transactions expected to decline by 10% next quarter.
- In China, Starbucks faces macro and competitive challenges, with significant competition from low-cost brands like Luckin Coffee and Mixue.
- Without a visible turnaround in same-store sales, Starbucks stock could face downside risk, making it a “show me” story for fiscal 2025.
NickS
Starbucks (NASDAQ:SBUX) released its preliminary Q4 and FY2024 results, which showed further weakness in its domestic and international fundamentals. US comp sales were down 6%, and Chinese comp sales were down 14%. The company also suspended its fiscal 2025 outlook in light of the ongoing fundamental challenges.
SBUX now expects FYQ4 comp sales to decline by 7%, driving a consolidated revenue decline of 3% y/y to $9.1bn and a GAAP EPS decline of 25% y/y to $0.80, which are largely in line with consensus.
It is worth recalling that the stock was up more than 20% after SBUX announced the new CEO back in August, which largely drove the YTD share price recovery. With the euphoria around the new CEO gradually dissipating, we believe that investors should shift their focus to the fundamentals of the business, that Starbucks will need time to address the existing challenges and that a brand turnaround strategy is unlikely to materialize in the near term.
SBUX is facing several challenges, both in the US and in China.
The challenges in the US related to constrained consumer spending and poor app experience have been widely documented. This challenge appears to be an ongoing theme, with US comparable transactions expected to decline by 10% this upcoming quarter and average ticket size expected to increase by 4%. The company pointed out that the investment in both products and in-app promotion failed to drive meaningful reacceleration in customer behaviors, particularly in the Starbucks Reward and non-SR segments.
Although improving the app experience by enhancing the wait time precision may address a large part of the consumer experience challenge, this may require a larger improvement in store efficiency and production workflow that may require multiple quarters to implement and adjust, which may partially explain why the company has ceased issuing the 2025 outlook.
Although China remains a small portion of the overall operating profit contribution, the current optic on China is not constructive to SBUX’s current fundamentals. China continues to see a combination of macro and competitive challenges, as implied by the 8% decline in average ticket size (price competition) and 6% decline in comparable transactions (macro weakness and wallet shift to value alternatives).
Luckin Coffee (OTCPK:LKNCY) is perhaps SBUX’s biggest competitor, with over 40% share in both GMV and cups sold on Meituan. However, it is worth noting that Luckin is not the only low-cost competitor that SBUX faces, and other low-cost leaders are driving the deflationary environment in China.
Most notably, Mixue has emerged as the country’s low-cost leader. China’s broad consumption downgrade trend positions Mixue favorably, given that its products, on average, are sold at ~Rmb6/unit for both tea and coffee, which is well below SBUX, which sells its cheapest coffee at around RMB 30-35 and Luckin’s at RMB 10.
Additionally, Mixue’s focus on delivering superior taste to unsophisticated coffee drinkers at an affordable price is particularly attractive, especially in lower-tier cities where consumers place lower emphasis on the nuance of coffee quality (i.e. bean quality, taste etc.) and instead prefer coffee-infused beverages that simply “taste good”. This consumer preference positions SBUX unfavorably for China’s lower-tier cities, given that it diminishes SBUX’s core differentiation relative to competing coffee chains, milk tea and other beverage providers.
Per its Hong Kong prospectus, Mixue generated revenue of RMB 15.4bn for the first nine months of 2023 (+46% y/y), a net profit margin of 15%, and FCF of over RMB 1bn.
Mixue’s core products include fruit drinks, tea, ice cream, and coffee, priced at around $1 or RMB6. The firm has two brands: Mixue (focused on tea) and Lucky Brand (focused on coffee).
The company has come a long way since its early days, when it started with shaved ice and subsequently sold an RMB1 ice cream cone that enhanced Mixue’s brand equity. The fruit drink venture started with lemonade in 2013, followed by coffee (2017).
The company operates under a franchise model that allowed it to quickly scale its footprint to 36k stores in China and 11 overseas locations as of 3Q23, selling 5.8 billion cups during the period.
Although many would argue that Mixue (and even Luckin) does not compete directly against SBUX given their different market positioning largely in the low-end, the value proposition from Mixue is difficult to ignore for many consumers within China’s current macro context.
We note that a typical Americano costs less than $1 (RMB 6), and a latte costs $1 (RMB 7). The beans are sourced from Ethiopia, Columbia, Brazil, and Indonesia, while the roasting plant equipment is from Probat and Buhler. For consumers who would like to get their coffee without an emphasis on brand, Mixue and the low-cost alternatives appear to be the better option.
With the competitive environment in China unlikely to abate any time soon, SBUX remains a “show me” story for the majority of fiscal 2025. Without a visible turnaround in same-store sales in the US and China, the stock could de-rate, and we could see downside risk to current consensus estimates.
SBUX is scheduled to release its full-quarter results on October 30.
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