Starbucks (SBUX -2.79%) is scheduled to report its fiscal second-quarter results on April 25 after the market closes, and the expectations, quite frankly, are a little bit muted. The company's own guidance calls for sales to grow "only" 5%-7% in 2019, and for comps -- sales at Starbucks stores open more than one year -- to increase 3%-4%. Moreover, analysts who cover the company (Starbucks doesn't offer quarterly guidance) expect earnings of $0.56 per share, 5.7% higher year over year.
These metrics represent a slowing from the Starbucks of only a few years ago, and with the stock price up more than 50% since last summer and near all-time highs, it's possible Mr. Market could be expecting a "beat" from the coffee giant.
Instead of falling down the rabbit hole of trying to prognosticate whether Starbucks will "beat" estimates and how the market will react, here is a closer look at three of the most important things investors should want to take away from this week's earnings release with a better understanding.
The China strategy
For the past several years, Starbucks management has regularly called China the company's biggest future market. Considering coffee's minuscule rate of consumption there compared with most Western countries, as well as China's ongoing rate of economic growth that has it on track to be the home of 500 million middle-class people in only a few years, it's easy to see why China gets so much attention -- and investment -- from the company.
Yet over the past year and change, aggressive and increased competition has taken a bite out of the China segment's impressive growth. Comps in the Middle Kingdom have slowed sharply and even went negative at one point, though they have returned to modest growth the past two quarters.
On one hand, aggressive expansion from competitors is concerning when they're taking share. But on the other hand, China is so untapped as a coffee market, it shouldn't be unexpected and is probably more of a positive indicator than a bad thing.
What should investors watch for? Ideally, signs that comps are improving, but also an update on the company's expansion plans. Luckin, a start-up that's now planning to go public, is challenging Starbucks, primarily on price, and has an aggressive expansion plan that would make it bigger than Starbucks in China by the end of 2019, based on the two companies' announced plans.
My guess is Starbucks' management will probably hold relatively firm on its plans, which are based on delivering a top-quality coffee beverage and experience, not the cheapest coffee. That could mean some short-term pain if Luckin and others take sales away from existing Starbucks stores. But Starbucks has proved time and again in every other market that it can win on product over price and deliver big profits as a result.
U.S. traffic and the new rewards program
Starbucks' domestic results are inextricably tied to its rewards program, which the company recently tweaked again. Last quarter, CEO Kevin Johnson pointed out on the earnings call that there are 16.3 million active Starbucks Rewards members, 14% more than the year before. CFO Pat Grismer directly attributed Starbucks' comps growth as being "driven by our Starbucks Rewards loyalty program," a clear indicator that this program remains key to Starbucks' results. In the U.S., comps increased 4% last quarter, a slight acceleration from 3% comps growth in the sequential quarter.
Here's the rub: Starbucks' comps growth in recent quarters has been entirely a product of higher prices and bigger orders. The company breaks comps out in "change in transactions," a solid proxy for traffic, and "change in ticket," which includes the effect of both higher prices and additional items, such as food, that customers add to a transaction.
Last quarter, Starbucks reported a flat transactions count. On one hand, it's not precisely a bad thing that Starbucks is holding firm on orders at existing stores, particularly considering retail traffic in general at many of the malls and shopping centers continues to weaken as more shopping shifts to e-commerce. But at the same time, there's a limit to how much the company can raise prices and convince people to buy a cake pop or salad to grow sales.
Well, Starbucks management has made engaging both casual customers and regular customers alike to drive increased traffic a priority. The tweaks to the Rewards program, which makes it easier for members to redeem rewards in a more tailored way, are specifically aimed at this goal. Furthermore, the company has recently opened its Mobile Order & Pay app to allow for non-Rewards members to place orders, while continuing to add more automation and digital enhancements to the behind-the-counter area to help baristas more quickly and accurately prepare orders.
In addition to the raw comps data -- both for transactions and change in ticket -- investors should pay close attention to how these initiatives are working and for future plans to continue and expand.
Making the most of existing operations
Few retail operators are as employee-focused as Starbucks when it comes to pay and benefits, and it's likely the company will continue to be a retail leader in compensation. At the same time, the company realizes it can, and should, do a better job of leveraging its human capital to deliver the best experience for customers it can, as well as utilizing technology to help that human capital deliver a fast, high-quality product and experience.
According to last year's investor day presentation, the average Starbucks store employee (called a partner) spends 40% of his or her time in non-customer-facing actions. These roles include important cleaning, restocking, and training activities, but also inventory, manual schedule building, and other administrative tasks, much of which the company has identified as being arduous and, if not unnecessary, then overly time-consuming.
For this reason, the company is in the early stages of a plan to reduce how much time employees spend on non-customer tasks, prioritizing those that directly support customer service and reducing the others as much as reasonably possible, as well as shifting them to non-peak hours and after closing. Management expects these actions will lead to improved service levels, faster throughput at peak periods, and higher operating profits at the store level, particularly at its busiest stores.
It's expected it will take a couple of years to implement all of the anticipated improvements across the company, but this quarter will give us some indication of how management sees the process going so far. As growth slows, finding ways to wring more profit from existing operations will go a long way toward Starbucks' ability to continue growing profits.
Stay tuned for our take on the 25th
Whether Starbucks beats Mr. Market's expectations this week -- and how Mr. Market will react -- is the kind of tea-leaf reading we'll leave to others. More important to the long-term thesis is how well the company executes on its plans, and whether those things drive improved sales and profits over time.
If the company can execute with the same level of competence it has in the past, that's what will drive investors' returns, not whether you can guess right from one quarter to the next. Be sure to check back in a few days for a closer look at Starbucks' results after earnings are out.