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Starbucks Is Shrinking in Order to Grow

By Billy Duberstein – Jun 12, 2020 at 7:15AM

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The COVID-19 pandemic is forcing even companies as strong as Starbucks to change their ways.

Shares of Starbucks (SBUX -2.67%) fell over 4% on Wednesday, June 10, after the company filed a report with the Securities and Exchange Commission that gave new forward guidance well below analyst expectations. While Starbucks did note that it had seen improving traffic trends as more and more stores reopened, those improvements are coming off a very, very low base.

In addition, Starbucks announced a speeding-up of plans to transition some of its cafes in busy city centers to a new "Starbucks Pickup" format. It also suggested it may downsize some of its store associates, or transfer them to reduced hours. This paints a picture of a company that isn't fully recovered from the COVID-19 pandemic, and might not be for a while.

A Starbucks small-format store with a sign saying Drive Thru

Image source: Starbucks.

Improving trends, but lower-than-expected guidance

In the release, Starbucks outlined the same-store-sales trajectory in both its U.S. and Chinese store bases. China was obviously affected by coronavirus first, and is further along in its recovery:

Metric

April

May

Last Week of May

Same-store sales, U.S.

(63%)

(43%)

(32%)

Same-store sales, China

(32%)

(21%)

(14%)

Data source: Starbucks SEC filing, June 10.

On the back of these improving, yet still-depressed traffic trends, Starbucks is presenting new guidance for its third and fourth quarters of fiscal 2020, as well as full-year earnings per share. All figures are for adjusted (non-GAAP) EPS:

  • Q3: A loss of between $0.70 and $0.55 per share
  • Q4: Positive earnings of $0.15 to $0.40 per share
  • Full year: Positive earnings of $0.55 to $0.95 per share

These numbers were below average analyst expectations of $1.37 in adjusted EPS for the full year. Contributing to the worse-than-expected results was Starbucks' continuing to pay all of its employees for part of the third quarter, and to pay all benefits, even to employees on unpaid leave.

However, in the release, Starbucks suggested that time may be running out for retaining all of its employees through the crisis. In the filing, the company said it was "evolving these programs to continue to support our partners while balancing the needs of our business, notably a need to align labor schedules and hours with customer demand as traffic fully recovers over time." Basically, Starbucks is finally admitting that it won't be able to restore full hours to store associates anytime soon, and is looking for ways to support people transitioning to unpaid leave, or leaving the company altogether.

Smaller-format Starbucks stores may be coming to an area near you

In addition to what looks like upcoming labor cuts, Starbucks is also seeking long-term cost efficiencies in real estate. Apparently, it had already noticed a trend: About 80% of its customers come into a cafe and take out their orders "on-the-go." So plans have been in the works to roll out a new, smaller-store format called "Starbucks Pickup" that's mobile-order and takeout-and-delivery only.

In light of COVID-19, over the next 18 months, Starbucks will be accelerating its rollout of the new store format, replacing many existing cafes in crowded cities. Thus, it appears Starbucks will be downsizing its current full-sized cafes and replacing some with the new Starbucks Pickup locations. Overall, Starbucks plans to close 400 stores in the U.S. and Canada and replace them with these smaller-format stores.

It appears that Starbucks thinks it can achieve the same flow of traffic (or better) with less real estate in high-priced city centers, leading to better margins as sales recover over the longer term. The smaller-format Pickup stores may also be more desirable for customers should the COVID-19 pandemic last for longer than many expect, since many customers might still shy away from more crowded traditional cafes.

Short-term cautious, long-term optimistic

Starbucks' stock had rallied hard off its March bottom, so it's not surprising to see the stock sell off on not-so-great guidance for the next two quarters. In addition, Starbucks is one stock that could really feel long-term effects from COVID-19, since the company generates most of its revenue through its (usually) crowded retail cafes.

Investors should expect this year and next year to have rocky results. However, Starbucks' top-notch treatment of its employees through this difficult time -- and management's proactive adaptation to new store formats appropriate for changing customer tastes -- should enable the company to recover profitably over the longer term.

Starbucks' valuation is still a bit pricey in relation to its current earnings trajectory. But investors with a longer time horizon might contemplate starting or adding to a position, if the stock underperforms through the difficult period ahead.

Billy Duberstein owns shares of Starbucks and has the following options: short June 2020 $30 puts on Starbucks and short June 2020 $69 puts on Starbucks. His clients may own shares of the companies mentioned. The Motley Fool owns shares of and recommends Starbucks. The Motley Fool has a disclosure policy.

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