It may be surprising that a company as well-run as Starbucks (SBUX +1.54%) has been a lagging stock over the last few years, but it's true. While Starbucks is probably as much a part of people's daily routine as any other company, lower foot traffic across malls and brick-and-mortar retail has taken a toll on Starbucks' growth. However, the company is still churning out positive same-store sales numbers, well outpacing the industry, which shows its strength even in a difficult environment.
But after a rough year, Starbucks may now actually begin benefiting from this seemingly negative phenomenon, and possibly in a big way.
Starbucks Chairman Howard Schultz. Image source: Starbucks.
Desperate landlords
While apartment rents are going up in large parts of the country, the opposite is true for commercial retail. Starbucks' founder Howard Schultz, it should be noted, saw this coming as early as 2013. In 2016, Schultz wrote that the effect of online shopping and e-commerce would significantly disrupt the entire physical retail industry.
That, unfortunately for Starbucks, proved true. In fact, over 6,400 overall retail stores closed last year, with another 3,600 expected to in 2018. According to a recent report by Credit Suisse, some 20% to 25% of malls could close over the next five years. Starbucks suffered along with others, as even it could not overcome this societal transformation. The company shuttered all 379 U.S. Teavana stores last summer, many of which were located in malls.
Now Schultz is making a new prediction, only this time, it's positive. Due to the massive amount of closures, combined with Starbucks' strength and ability to attract visitors to its "third place," the company finds itself in a great position to negotiate lower rents.
Schultz emphasized, "This is GOOD NEWS for Starbucks and the future of our unit economics... This is not going to be a cyclical change in our occupancy expenses, but a permanent lowering of the cost of our real estate."
Ownership benefits
While you may think all major restaurant chains will benefit from this change, most will not benefit nearly as much as Starbucks. That's because unlike many other fast-food chains, Starbucks operates most of its U.S. stores. That contrasts with more heavily franchised restaurant chains such as McDonald's (MCD +0.63%) or Dunkin' Brands (DNKN +0.00%). In a franchise model, the franchisee actually owns the business, and is thus responsible for rent costs.
In its most recent quarter, Starbucks operated about 56% of its "Americas" segment stores, but the self-operated stores made up nearly 90% of the segment's revenue. Starbucks doesn't break out occupancy costs specifically, instead grouping rent in with its cost of food, but these combined costs were the segment's largest expense: 37.6% of revenue last quarter, up from 36.1% in the prior year.
Another restaurant chain that operates all its own stores is Chipotle (CMG +2.79%), and it does break out occupancy costs separately. For the beleaguered burrito slinger, occupancy costs were about 7.5% of revenue last quarter. If Starbucks has similar numbers, and can drop rent costs just 10% or more, the effect on the company's bottom line could be significant.
Timing couldn't be better
The relief to Starbucks would certainly be welcomed: In spite of 2% same-store sales growth in the Americas segment last quarter, Starbucks' operating margin contracted 100 basis points due to a "food related mix shift."
With lower rents on the horizon, the company looks poised to regain at least some of that margin as its leases roll off over the next few years. That should help the company's bottom line without having to raise prices.
Despite the ongoing challenges of brick-and-mortar retail, lower rents should be a big boon to Starbucks, its shareholders, and its growing dividend, which the company recently hiked by 20%.
