Shares of Starbucks (SBUX -1.31%) jumped on Wednesday after the java giant turned in better-than-expected results in its second-quarter earnings.
The numbers were ugly, as expected. Starbucks bore the brunt of the impact from the coronavirus pandemic, since the majority of its U.S. stores were closed at the beginning of the quarter, and the company lost sales as normal commuting routines were disrupted. Let's look at the headline numbers:
- Revenue fell 38% to $4.22 billion, which beat estimates at $4.06 billion. Comparable-store sales dropped 40% in the quarter as transactions fell 51%, though the average ticket increased by 23% as customer behavior changed, leading to more group orders.
- On the bottom line, the company posted a generally accepted accounting principles (GAAP) loss of $0.58 per share, or a $0.46 loss on an adjusted basis, which compared to estimates of a loss of $0.59.
- Starbucks said COVID-19 caused a $3.1 billion loss in revenue in the quarter. Without that, it said, sales would have increased by about 7%.
While Starbucks may have just had the worst quarter in its history, the company is rebounding quickly and expects to return to profitability in the current quarter, forecasting adjusted earnings per share of $0.18 to $0.33. Investors also cheered when the company said that comps at the 3,100 U.S. stores that were open the entire quarter were up 2% in July so far after a drop of just 1% in June. That's evidence that stores in areas less affected by the pandemic aren't seeing any sales impact at this point.
Starbucks' return to growth at those stores and its profit forecast show that even as the company is facing challenges from the pandemic, it is also grabbing market share from struggling competitors. Here are three reasons Starbucks should emerge stronger from the crisis.
1. Rewards members are surging
Starbucks' Rewards program is one of the most successful restaurant loyalty programs in the world and may be the company's most effective competitive advantage. The Rewards program, along with the Starbucks app, gives the coffee chain the ability to connect with customers and invite them in for frequent visits with discounts and happy hour specials, creating a virtuous cycle that leads to more loyalty.
Active rewards members in the second quarter actually declined 5% to 16.3 million due to store closures, but 3 million customers downloaded the Starbucks app in the quarter, a 17% increase from the second quarter. Additionally, sales growth from Rewards members turned positive in July, and the percentage of orders coming from Rewards members increased 4 percentage points in the quarter to 46%.
Mobile Order & Pay has also been a source of strength, increasing to 22% of total transactions, up 6 percentage points from a year ago. It gives Starbucks customers an option that many of its competitors can't match, and the same is true for drive-thru and other pickup options like curbside and entryway pickup.
2. Channel development is a profit machine
Starbucks is more than just a chain of coffee shops. It also has a thriving business that it calls channel development, which sells products like bagged coffee and bottled drinks in grocery stores, convenience stores, and other outlets.
Though channel development only makes up about 10% of the company's revenue during normal times, it is the company's most profitable business in terms of operating margin, and the segment actually saw revenue grow by 5% in the quarter, adjusted for unfavorable activities related to transitioning to the Global Coffee Alliance, a partnership with Nestle.
Management also said that it increased market share in both packaged coffee, where U.S. sales rose 21% compared with 13% growth for the industry, and domestic ready-to-drink beverages, where sales rose 11% in the period, gaining 2 percentage points of market share.
3. China still has a lot of potential
Early in the year, Starbucks' exposure to China seemed like its biggest weakness since that country was the first to shut down from the pandemic. But these days, its position in China gives it a valuable ballast to the sluggish recovery in the U.S. business. China sales are rebounding ahead of those in the U.S., and the company expects performance to normalize in its No. 2 market by the end of the year, while it doesn't see that happening until next March in the U.S.
After closing nearly all of its China stores in February, Starbucks now expects comps there to be flat to down 5% in the current quarter. It also returned to its growth plans in the key market, aiming to add at least 500 new stores in the country this fiscal year. Starbucks has also enabled Mobile Order & Pay through other apps like Alibaba's Alipay and Taobao apps, and it has made Starbucks delivery available through Tencent's WeChat.
With Luckin Coffee sidelined by fraud revelations, Starbucks' path in China remains wide open, and the company should return to growth as the Chinese economy recovers.
The future looks bright
The COVID-19 pandemic has dealt a blow to much of the restaurant industry, but Starbucks is quickly emerging from the depths of the crisis as it moves further into recovery mode and adapts to the crisis with innovations like Pickup stores. As it does so, it has earned record customer-connection scores, and it should grab market share from weaker franchised competitors and independent coffee shops struggling to stay afloat.
When the pandemic ends, the coffee king will likely find itself in an even stronger position as it expands in China, reaps the windfall from its channel development business, and leverages advantages like its Rewards program to keep delighting customers.