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Starbucks' Path to Recovery Comes Into Focus

By Jeremy Bowman – Updated Apr 29, 2020 at 4:33PM

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Sales are plunging at the coffee chain, but stores are set to reopen.

Few companies have been battered by the coronavirus pandemic as much as Starbucks (SBUX 2.98%) has. As a restaurant operator, Starbucks' industry is being directly impacted by the outbreak while restaurant dining rooms across the U.S. and much of the world have closed to stop the spread of the virus.

And Starbucks first faced challenges from COVID-19 in China, starting in January, before the virus spread to the U.S. and began forcing businesses to close in March.

As a result, Starbucks' second-quarter earnings report for the January-to-March quarter showed both sales and earnings down, but a strong start to the quarter in the U.S. helped deliver solid numbers given the headwinds. Comparable sales in the period fell 10%, and overall revenue declined 5% to $6 billion. On the bottom line, adjusted earnings per share fell from $0.60 to $0.32. However, investor attention was on the company's path to recover from the crisis, as Starbucks plans to reopen U.S. stores next week.

A group of Starbucks workers in China talking around a table.

Image source: Starbucks.

The China situation

Starbucks had already tossed out its guidance for the year due to the uncertainty around COVID-19. However, the company did provide a forecast for sales in China after comps in its second-biggest market plunged 50% in the second quarter. Almost all of Starbucks' stores in China are open again, but most are operating with limited hours, limited seating, and enhanced safety protocols.

For the current quarter, management sees comparable sales recovering to negative 25% to negative 35% after a 35% decline in April, and in the fourth quarter, a comps decline of 10% to flat. CEO Kevin Johnson expects a full recovery by the end of the year, in September. For the full year, comparable sales in China are expected to fall 15% to 25%.

Johnson said several times on the earnings call that the progress the company has made in China gives it confidence that the challenges from the coronavirus are temporary and that the company will emerge from the crisis stronger.

Starbucks' expansion in China is also continuing apace. The coffee chain expects to open another 500 locations in this key growth market, extending its lead in China at a time when rival Luckin Coffee has faltered over fraud allegations and Starbucks' premium positioning and customer experience remain unrivaled.

The long slog at home

In the U.S., Starbucks' comparable sales have fallen by between 60% and 70% since the stay-at-home orders began last month, and the company is burning about $125 million a week, which explains why it's eager to reopen stores.

However, the quarantine period hasn't been an entire loss for Starbucks. At stores that have remained open for drive-thru and delivery, comparable sales have only fallen 25% in April, a positive sign for reopening. In fact, about 60% of Starbucks have drive-thrus and 80% of orders in the U.S. are to go, so its business fits well with social distancing measures. The company is also planning a marketing push for its reopening, which should help give sales a boost, since its marketing had been turned off while stores were closed.

Management also warned that results in the third quarter would be significantly worse than the second because it has taken the brunt of coronavirus impact in the U.S. in the current quarter, and that the negative impact would extend into the fourth quarter.

That means that the path back to recovery in the U.S. will likely take longer, since shutdowns have lasted longer here and the impact of the virus has been greater. The outbreak is reportedly largely under control in China, while it continues to spread in the U.S., adding to the uncertainty as Starbucks reopens stores at home.

Why Starbucks is still a long-term winner

Despite the challenges Starbucks is facing during the coronavirus crisis, it's still in a position to emerge from the pandemic stronger and gain market share, given that it has a number of advantages over rivals, including chains like Dunkin and Luckin and independent coffee shops. For example, Starbucks has a thriving channel-development business built around products it sells in supermarkets, convenience stores, and other such establishments. That business is highly profitable, generating an operating margin of 36.5% and an operating profit of $189.6 million in the second quarter.

Starbucks' Rewards program and its digital reach are also unmatched in its industry; U.S. Rewards members increased 15% to 19.4 million last year, giving the company a direct pipeline to communicate with its best customers once stores are open and a way to lure them back in with perks and rewards. Similarly, its strength in digital and delivery and new techniques for transferring orders like Entryway Handoff give it several ways to accommodate customers during social distancing.

Finally, Starbucks continues to set the standard in employee benefits, recently adding a mental health benefit, and has paid bonuses and higher wages during the outbreak. CFO Patrick Grismer best summed up this long-term approach on the earnings call, saying: "The scale of our company, combined with the strength of our balance sheet, enables us to manage our business for long-term growth while dealing with short-term business realities. In essence, we are investing in relationships with key constituents, not only to preserve those relationships but to strengthen them for the future."

That long-term focus will strengthen Starbucks' advantage and help guide its recovery. Though results will be ugly for the next few quarters, the company is continuing to expand and should emerge from the crisis larger and with increased market share.

Jeremy Bowman owns shares of Starbucks. The Motley Fool owns shares of and recommends Luckin Coffee Inc. and Starbucks. The Motley Fool recommends Dunkin' Brands Group. The Motley Fool has a disclosure policy.

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