Shares of Starbucks (NASDAQ:SBUX) are down by nearly 11% in the last year, mostly because of investor concerns about decelerating growth. However, management believes this is just a temporary slowdown, which could mean the short-term weakness in Starbucks' stock is creating a buying opportunity for long-term investors in the coffee powerhouse.
Is Starbucks getting cold?
Starbucks' total revenue during the quarter ended in June (the third quarter of the fiscal year for the company) increased 7% to $5.24 billion, while global comparable-store sales jumped 4% versus the same period in 2015. This is still a strong performance by industry standards, but it represents a slowdown for Starbucks in comparison to growth rates in prior years.
As a reference, fast-food giant McDonald's (NYSE:MCD) reported a 4% decline in consolidated revenue last quarter, mostly because the company is aggressively refranchising stores. On a comparable-store basis, McDonald's announced a 3.1% increase in global comparable revenue.
Competitor Dunkin' Brands (NASDAQ:DNKN) is doing considerably worse than both Starbucks and McDonald's. The company registered a 3.85% increase in revenue during the second quarter, with comparable sales in the U.S. growing 0.5% at Dunkin' Donuts and 0.6% at Baskin-Robbins. In international markets, Dunkin' Brands reported a 3.1% decline in comparable sales at Dunkin' Donuts and a 6.6% contraction at Baskin-Robbins.
Nevertheless, investors in Starbucks typically expect above-average performance from the company. Prior to its most recent report, Starbucks increased comparable-store sales at more than 5% for 25 consecutive quarters. Even if Starbucks is doing better than the competition, growth slowed down last quarter, and this is arguably the main reason the stock is under selling pressure.
What Starbucks' CEO wants you to know
Starbucks founder and CEO, Howard Schultz, was quite clear during the conference call on the fact that he considers the deceleration in growth a temporary problem as opposed to a sign of harder times ahead. In his own words:
On today's call we will demonstrate with clarity and specificity why our US comps in Q3 were an anomaly and that we have clear line of sight to returning our business to historic levels of comp growth, which has been at or above 5% for the past 25 consecutive quarters.
According to Schultz, the main reason for slowing growth in the U.S. last quarter is that Starbucks made two big moves at the same time. The company is modifying its customer loyalty program from a frequency-based to a spend-based model. The launch of the new customer loyalty program coincided with the company's much-important frappuccino happy hour promotion last quarter, an annual event that usually has a big impact on revenue.
Schultz explained in the conference call:
What we underestimated was the interdependence of Starbucks rewards and happy hour, and that two powerful initiatives competing for partner and customer mind share during a discrete period of time would disrupt what should have been strong, positive interdependence and leverage.
Growth drivers remain solid
Schultz is, of course, an interested party in this discussion, so investors need to take statements from Starbucks' management with a grain of salt. However, it's important to note that the company's growth drivers still look quite healthy.
Starbucks is one of the most powerful brands in the consumer sector, and customer loyalty can be an enormously valuable advantage for investors over the long term. Starbucks has over 12.3 million active rewards members in the U.S. alone, and the company gained 2 million new members year over year. In addition, Starbucks is an industry leader in terms of mobile ordering and payment technologies, a major plus in the industry nowadays.
Even in highly penetrated markets such as the U.S., menu innovation is a smart avenue through which to keep revenue growing. Over the past several years Starbucks made important acquisitions such as La Boulange, Teavana, and Evolution Fresh, and the company is smartly leveraging those purchases to drive sustained revenue growth and diversification into different product categories.
The company still has plenty of room to expand its store base in emerging markets, and China looks like a particularly promising country over the years ahead. Starbucks has nearly 2,300 stores in 100 Chinese cities, and it's planning to open 500 new stores per year in China over the coming five years. Comparable sales in China grew 7% last quarter, so demand looks as strong as ever in this key market.
Packaged goods is another compelling growth driver for Starbucks, allowing the company to capitalize on its brand value and expand revenue without the need to open new stores. Revenue in this segment grew 9% to $440.8 million last quarter, and operating margin in packaged goods was an impressive 42.6% of sales during the period.
Only time will tell for certain if the slowdown in growth is just temporary or something more permanent. However, customer loyalty, product innovation, emerging markets expansion, and opportunities in packaged goods look like compelling growth engines for Starbucks in the years ahead.