Starbucks (SBUX 3.87%) nailed its first-quarter earnings report Tuesday. But in spite of strong results across the board, investors were spooked by the outbreak of coronavirus in China. Shares were trading down 2.7% in afternoon trading Wednesday as a result.
Starbucks said that currently more than half of its stores in China were closed as it responded to the outbreak. The java giant also said it would have raised its full-year guidance in operating margin and earnings per share, but it was exercising caution, as it said the impact from the store closures would be material to its second-quarter and full-year results.
Though that news is clearly a setback for the coffee chain, investors seemed to be overreacting to it. We'll discuss why, but first let's review a few key facts about the coronavirus.
Some coronavirus facts
According to authorities, the new coronavirus came from a seafood market in China's Wuhan province and was first detected on Dec. 12, and identified on Jan. 7. The first death from pneumonia-like symptoms occurred on Jan. 9, and by Jan. 13, the disease had spread to other countries.
Over the last week, cases have skyrocketed and fears about the disease's spread have multiplied. Wuhan has been placed on lockdown. By Jan. 28, the death toll reached 100 globally, and there are more than 4,500 confirmed cases. At this point, relatively little is known about the disease's potential impact, or even its mortality rate. But restaurants can easily spread diseases, those in China are being cautious, and many have temporarily closed their doors or cut back hours.
Why Starbucks investors need not worry
Though the coffee chain will take a hit from the outbreak, Starbucks' vulnerability isn't as great as some investors might think. The java giant has spent years talking up the market, but today only 10% of its revenue and a slightly higher percentage of its operating income come from China.
In a worst-case scenario, if Starbucks were forced to close all of its stores in China, the company would still be fine. Its revenue and profits would just be 10% lower. However, if the outbreak worsens, the company could actually be better off than a number of American companies and local rivals.
It's hard to understate the importance of China in the global economy. Nearly one-fifth of the world's population lives in China, and the country contributes nearly 20% of the world's gross domestic product (GDP), making it the second-biggest economy after the U.S. Hundreds of multinational enterprises count on the Chinese market the way Starbucks does, looking to it for growth -- and because it's a huge market.
China is also the world's biggest manufacturer, and a major supplier of everything from tech gadgets and electronics to apparel and toys to raw materials like steel and concrete. Therefore, a sustained and deadly outbreak in China would likely devastate the global supply chain and economy. Since 90% of Starbucks' revenue comes from outside of China and it isn't dependent on China as a supplier, the company would be relatively protected from any shock waves that could affect manufacturing and supply chains.
Many investors have felt that Starbucks' biggest threat in China is Luckin Coffee (LKNC.Y 2.94%), a homegrown chain specializing in pickup and delivery that now has more locations in China than Starbucks, barely two years after it opened its first store. There's no question that Luckin is seeing incredible growth, but the company is still losing gobs of money and only has stores in China. If the coronavirus situation gets much worse, it will be a significantly bigger problem for Luckin than for Starbucks. That gives Starbucks the advantage in such a scenario over the long term, as it can better absorb any costs that result from store closings. Luckin has yet to make a public statement on coronavirus, but Reuters said that Luckin plans to keep stores in Wuhan closed through the week-long Lunar New Year holiday.
Why Starbucks is being punished
Starbucks may be just as threatened by coronavirus as hundreds of other companies, but as a restaurant chain it can't recoup sales lost from having stores closed. If a customer doesn't come in for a cup of coffee today, they won't come in and get two cups tomorrow. A business like Apple or Nike, on the other hand, could reasonably count on customers upgrading their phones or buying new pairs of sneakers next week, even if its store is closed this week.
Starbucks won't get back these lost sales, but the company is doing the right thing by protecting its brand, employees, and customers from a new and potentially dangerous outbreak. Its financial results may take a hit this year, but over the long term this will be little more than a blip for the coffee giant.