The COVID-19 coronavirus outbreak is triggering an unprecedented wave of travel bans, border closures, and lockdowns. Many countries have also ordered malls, cafes, cinemas, and other areas where crowds gather to shutter, all in an effort to contain the spread of the disease. Consumer companies with retail outlets have announced store closures all over the United States as the situation goes from bad to worse. Apple, for instance, has announced that it would close many of its stores until further notice.
Food and beverage are in the same boat. On March 15, Starbucks (SBUX 1.45%) announced that it will temporarily be closing some stores all over the U.S. for at least two weeks and shifting to a "to-go" (i.e. take out) model. Additional measures include pausing the use of all seating and changing the company's cash-handling procedures.
In an update on March 22, Starbucks said it will go one step further by closing all company-operated cafes and reducing its service to drive-through and select grocery locations in both the U.S. and Canada for two weeks beginning March 20. The situation remains fluid, but it seems that this may be a drawn-out battle to contain the virus -- investors should be prepared for significant short-term financial pain ahead for the coffee chain.
However, here are three reasons why I believe Starbucks is well positioned to overcome this crisis.
Strong brand presence
Starbucks has a strong brand presence not just in the U.S. but also globally. Over the years, management has steadily grown the company's footprint in regions such as Asia and South America. Though Starbucks may have shuttered its stores temporarily, people will be constantly reminded of the brand every time they pass by a mall or a street corner.
This visibility means that the company's name will always remain in people's minds, even as their daily activities and habits are being disrupted by lockdowns. These tough measures, in turn, create pent-up demand for the company's products that will bring customers back in droves once the situation eases.
Sticky customer loyalty program
Starbucks runs a loyalty reward program that has seen membership grow rapidly over the years. In its fiscal 2020 first quarter, the company reported that membership in the U.S. was up 16% year over year to 18.9 million members.
The healthy growth in this member base enables Starbucks to retain customers and engenders strong brand loyalty. This program is part of Starbucks' digital flywheel strategy that also makes use of artificial intelligence to deliver a personalized experience for each customer.
Not many coffee chains have such an established loyalty program, and this is one differentiating factor that will keep customers coming back when stores reopen. As a gesture of goodwill, Starbucks has also announced that it will delay the expiration of all accumulated rewards points scheduled to expire between now and June 1, 2020.
Consistent free cash flow generation
As you can see in the chart below, Starbucks has had a great track record of consistent free cash flow generation (operating cash flow less capital expenditures). This is despite spending significant sums of money on new store openings in recent years.
Though the COVID-19 closures will surely negatively impact operations in the next few quarters, the company is poised to quickly get back on track once the situation normalizes.
Bouncing back strongly
These three factors make me confident that Starbucks can recover quickly. In the meantime, however, investors will have to tolerate short-term pain as store closures may be extended, depending on how the situation evolves over the coming weeks.
Starbucks' recent experience dealing with COVID-19 in China offers clues as to the company can proceed in its home market. At the peak of the outbreak, around 80% of stores had to close, and CEO Kevin Johnson recently described how management tackled various challenges, "Our team in China defined elevated cleaning protocols for stores and leveraged new customer experiences, such as contactless pickup and mobile order for pickup or delivery." And as the outbreak subsided in China, over 90% of Starbucks stores have reopened under modified hours and conditions.
This successful approach abroad should reassure investors and show the company can handle the temporary setback and bounce back much stronger thereafter. For the long-term investor, this represents a rare opportunity to build a position in Starbucks stock at a bargain price. The stock has fallen 25% year to date and is trading at a trailing price-to-earnings multiple of around 22, a significant discount to its five-year average of 30.