Why the Starbucks Stock Is Up

In this episode of Market Foolery, Chris Hill chats with Motley Fool analyst Dan Kline about the latest news and financial reports from Wall Street. They look at the quarterly numbers of Starbucks. A music streaming company now has more paid subscribers than it anticipated. A gardening supplier is crushing it on the Street. And there's a bold new deal in the movie industry.

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This video was recorded on July 29, 2020.

Chris Hill: It's Wednesday, July 29. Welcome to Market Foolery. I'm Chris Hill. With me today: our man in Florida, it's Dan Kline. Thanks for being here.

Dan Kline: Hey there, Chris. I'm caffeinated and ready to go.

Hill: [laughs] You're previewing the first stock on the docket for us today. We've got a landscape-shifting deal in the movie industry. We've got another boring business hitting a new all-time high, but we're going to start with Starbucks (SBUX 0.73%). Same-store sales in the third quarter fell 40%, but the loss was smaller than expected, the revenue was higher than expected, and shares of Starbucks are up about 4% today.

Kline: Yeah. Chris, can numbers be catastrophic and fabulous at the same time? [laughs] Because the challenge here is, and it's something that doesn't get talked about enough, but it came out in the McDonald's earnings call. Starbucks is a breakfast-driven business, and you know what people aren't doing? They're not getting up and going to work. So that is a big problem. Now, anecdotally, the Starbucks near me, there's two of them, are very crowded, drive-thru and pickup only; they're not open in the dining room. But the schedule is weird. People don't have to get coffee before they go in, so just some of the times they played best just haven't recovered and probably won't recover. But a lot of their loss was attributable to spending extra money to keep employees safe.

I'm not worried about their business. In fact, I think in the long term, they've educated customers to their digital system, which in a regular world, where sitting in a store, getting in line or going through a drive-thru or mobile order are available, I think they're going to make their stores more efficient, because more people that are in a rush are going to be able to order. I know I do it, when you're three minutes away from Starbucks, you put your order in, and it might say to you, hey, this might get done before you get there. And I go, hey, that's what I want, I want it to be done before I get there. And then, of course, you sit in the drive-thru line for 40 minutes and it's cold. So there's some problems with that, but yeah, I thought these numbers were encouraging.

And let's say their spin on the numbers felt very believable in terms of where they are in their recovery, how it tracks with China. I think I mentioned to you, Chris, I stopped at a Starbucks on the way back from Key West and the dining room was open. I just used the bathroom, I didn't even get anything, but I almost cried when I saw people hanging out in a Starbucks. It was such an important part of my life that's just not available at the moment.

Hill: Yeah, Kevin Johnson, the CEO, was on CNBC this morning, talking about what they learned from China, how they were able to take a lot, not everything, but take a lot of what they learned in the China reopening and bringing that to the U.S., making tweaks where they needed to. I really got the sense that, among other things, this is forcing Starbucks to make changes at a much more rapid pace than maybe they would have done [laughs] in a nonpandemic situation, that a year, two, three, four years down the line, conceivably, they end up with a more profitable business.

And he stressed this a couple of times, and I think this point applies to Starbucks, it applies to a lot of businesses. He was very quick to point out, this is not going to be linear, [laughs] this is going to go in the ebbs and flows, and that's something that I think every investor needs to bake into their expectations for so many businesses that we own shares of.

The other thing that was good to know, a little surprising, but still good to know, they expect to open, and they're on track to open, net 500 new locations in China this fiscal year. And right now, they're at about 4,400 locations in the U.S. Company-owned locations are somewhere in the neighborhood of 8,500. So they're not really taking their foot off the gas with respect to expansion in China.

Kline: No, Chris, they actually renovated one of the Starbucks near me [laughs] during the pandemic, which it seemed like, you might want to put that off a little bit, but it went well, from seeing it through the drive-thru, it looks nice. But the really important metric here, it's, yes, there is still full growth ahead, but people who ordered digitally, their tickets were about 20% higher. It's actually a little bit more than that. And that, I think, is something we've seen, again, with McDonald's. When they moved to a delivery model, when they moved to a kiosk model, you lose some of the shame. So I know. Like, I have a relationship with the baristas at my Starbucks. I maybe don't want to order the Frappuccino with extra cream and with more whipped cream and could you grind a candy bar into it. But I can do that on the app without the shame. And I think right now, we're all looking for ways to make ourselves a little happier, and we're probably being a little indulgent in our Starbucks orders, that may not continue to the tune of 23% or whatever the exact number was, but it's likely going to continue.

So as they train people to order digitally, to use the app, you're going to have happier customers, because your order is going to be correct, it's going to be customized, you know, if you want half cream, half skimmed milk, they can do that. If you want two pumps instead of four pumps, that's all really easy to do in their app. And you are going to get that little extra treat or something for later, because there's no shame factor involved. So I think they're leading toward behavior that's really going to reward them, especially when people start going back to some form of normal pattern.

Hill: Spotify (SPOT 0.12%) out with mixed results in the second quarter. Ad revenue was down, but paid subscribers are now up to 138 million; that's higher than expected.

Kline: Yeah, their number skyrocketed. I don't know what to make of this company. I'll cite our own Jason Moser, who's very bullish on them and thinks it's all about subscriber growth. I'm going to argue that I don't know how they make money. I think there's a fundamental problem with their business that what they're charging for subscription, what they're paying the labels, what the artist is getting paid, it isn't enough money. And one of the things Jason said in his social media post was, "I think people are underestimating how hard it is to switch." I don't think it's hard to switch at all. I've switched between Apple Music and Amazon based on devices. Now that you can have Apple Music on everything, I just have that.

I worry about this business. I love what they're doing in podcasts, I love the massive growth numbers, but they can't really raise prices unless the entire industry colluded to raise prices, and I'm pretty sure only Major League Baseball is allowed to collude. So you know, they're probably not going to call up Amazon and Apple and say, hey, can we all go to $12.99/month? So I don't know, it feels like a fundamental problem to me, but smarter Fools don't feel that way.

Hill: The question of pricing power is a good one. And I think it's one that Spotify hasn't answered yet. It doesn't mean they can't answer it at some point in the future. But there was a point in time when people questioned Netflix and its ability to raise prices. And they've proven to be very smart and judicious in the ways in which they do that. But to your point about the switching cost, I don't think anyone looks at the music streaming businesses the same way they look at video streaming, in the sense that you have to have more than one. I'm not saying that music streaming is a zero-sum business, but it is much closer to being a zero-sum game than video streaming.

You know, people are going to have multiple video stream businesses in their homes, they are going to have Netflix, Disney+, Hulu, whatever. You know, if you just go all-in on Amazon Unlimited Music, well, then you don't need Spotify, and vice versa. So I think that this has been a year for Spotify where they've been pretty aggressive in what they've gone after in terms of growth opportunities. You mentioned the podcast, we saw the deal recently with, I think, it was Universal Music Group, so we'll see the extent to which that actually pays dividends for Spotify in terms of marketing dollars.

But part of me wants to just fast forward one full year and just see what the numbers look like for Spotify, not just the paid subscribers, because that is an important metric, but how have these podcasts deals paid off? I've said before on this show, it's going to be interesting to see how happy Joe Rogan is six months into this deal, because he has an out clause if he wants to exercise it at some point.

Kline: So Chris, I think they have to make a hard decision. And they threw a lot of money at Joe Rogan, they threw a lot of money at Bill Simmons and The Ringer. Almost all of the podcasts they're paying for are on the free part of their platform. And in the case of The Ringer podcast, they're still on every other platform. So at least with Joe Rogan, his fans have to get the free version of Spotify, which could lead them to the paid version. I actually think they need to throw another $10 million, $20 million at Joe Rogan and bite the bullet with Bill Simmons and put them behind a paywall. Because I know, I am a giant fan of Bill Simmons. I listen to a ton of stuff on The Ringer. I just listened to their great podcast about "The Rise and Fall of HQ." I'd probably leave Apple Music and become a Spotify subscriber if they did that, but that's a big risk for them. Because there's a ton of ad revenue being generated by those podcasts on other platforms, but I feel like they're spending all this money for not exclusivity.

Hill: Let's move on to -- you know, yesterday we talked about Sherwin-Williams, today it's Scotts Miracle-Gro (SMG -0.68%). Third-quarter profits and revenue came in higher than expected. I can't believe what I'm about to say: They raised their dividend, they also declared a special dividend. The stock is up 12%, and this is another boring business that's crushing it.

Kline: It's a boring business that fills a niche. And, look, a lot of people are planting gardens at home, because they're bored. I mean, some people did it for food supply reasons. There was a time period during the pandemic where it felt like you might not be able to get all the things you need at the grocery store. But I think a lot of people are gardening. And, Chris, a lot of people might be using this for their semi-legal, depending where you live, growth purposes. You know, that's something we've talked about a lot on some of our cannabis shows. This is sort of an ancillary play in that business. It's kind of a safe way to bet on that. But they sell a product that people need with a name brand that means something; that's a really good position to be in.

Hill: It really is. And we talked about this a little bit before we started recording today. I mean, there are so many innovative businesses that are crushing it right now, [laughs] but I feel like, you could do pretty well over the next 10 years if you had a little spot in your portfolio for Sherwin-Williams, for Scotts Miracle-Gro, and I'll just throw Clorox in there as well. Again, not exciting businesses, not sexy, but they just dominate their categories.

Kline: Chris, they're like the Zoom of dirt. So we don't know, with Zoom, how many people are going to give up the product when we go back to a little more normalcy? But some of their user base, you know, my mom will probably not still be a Zoom customer when all of this ends though, maybe she will, because maybe she'll want to go to a dance class and not have to go into the studio because she's not feeling well. The same thing with backyard gardens. So people that are bored and out of work and felt like a garden was a great idea, they might move on, but a lot of people won't. That'll be a new hobby And you know, look, you have to buy more dirt every year, every season depending where you live. That's a solid business to be invested in.

Hill: AMC Theatres, which is the largest movie theater chain in the U.S., has struck a deal with Universal Pictures that would shorten the number of days that films need to run in theaters before going digital, before they make the move to video on demand. Currently the number is, I believe, 90 days. This deal would shorten it to 17 days. That's just three weekends that a Universal Picture or a Focus Feature Picture, these are the two studio brands under the Comcast umbrella, just three weekends they would need to run in AMC Theaters before they go digital. Is this a win-win deal? Because I get that -- you can talk me into AMC needed to make this deal, but it's hard for me [laughs] to see this as anything other than a bigger win for Comcast than it is for AMC Theatres.

Kline: So here's the piece we don't know. AMC is getting a piece of the digital pie. And I don't know if that means just when someone rents on their platform; they haven't released the details. If they're getting a straight percentage of any digital sales that go through certain platforms, that might be a win-win, but this isn't going to be just Comcast. There's no way Disney doesn't make the same deal and thereby all of the major movie chains will eventually make this. This changes movies.

We were already in a weird position for the future of movies, where, sure, you want to see the Avengers, you want to see Still Fast Way Furious on the big screen, but a lot of movies. One I'd point out, like, Knives Out, which was a pretty big theatrical hit, that movie would have played just fine on Netflix, earned a $20 on demand venue, it did not require the big screen touch. A lot of movies that used to get released in theaters aren't going to theaters, this creates a way for a movie to still qualify for, say, an Oscars run, be in theaters for three weekends for the, I hate to say, older folks, but you know, a lot of these pictures tend to be older folks seeing them, they can still go see them in the way they like to. And then they can quickly move to a digital platform and have a wider audience. You know, we saw this with Trolls World Tour, a movie that didn't make quite as much money as the previous Trolls, but it was more profitable for Comcast, because it skipped theaters. Now, obviously, that was during a pandemic, when parents were very hungry for stuff, but you're going to see a really weird setup, or something like a new Star Wars film. They have the right to put it on digital after 17 days, but if it's still No. 1 at the box office, making a $110 million a week, they're probably not going to put it on a home platform.

So this is going to be a really evolving tested-out way, but it means less movie screens, fewer movies are going to get released to theaters. It is a seismic change, it had to happen, but it's the end of movies as we know it.

Hill: A couple of thoughts here, just in terms of the stocks. Comcast up a little bit today. AMC Theaters down about 1%, 1.5%; I think that's, sort of, negligible. Shares of IMAX are down 10%. So when you think about what are the movies that you really want to see on the big screen, it is those big action films. And so I think it is telling that IMAX, which isn't involved in this deal, [laughs] is down 10%.

The other thought I had was in terms of Comcast and, if you're right, the other studios go this route. This absolutely reduces the marketing costs for them, doesn't it? Because if a movie is going to run in the theaters for 8 weeks, 10 weeks, that sort of thing, that is something you have to spend more money on in terms of television ads, that kind of thing. As opposed to, if it's just going to be three weeks, that's a really short burst. I don't know, I don't want to get too excited about, you know, as a Disney shareholder, what this might mean for marketing costs coming down, but my hunch is, they're going to come down for all these studios.

Kline: I don't think it means that much, actually; I hate to contradict you. But marketing costs are front loaded, especially for a blockbuster. So you know, let's pick the most recent Disney failure, and that's Solo. All the marketing money for that movie was front loaded to get a big opening-day weekend. When it doesn't have a big opening-day weekend, the only thing you could do is if the movie was really well received, you can start running like, it's A+ on Rotten Tomatoes. If it wasn't -- and Solo wasn't -- you start to cut your losses. I actually think, yes, because it's only a 17-day window, they'll be able to compact it and that will save them some money, but if they're then going to move it to, let's say, my theory is a paid tier on Disney+, where after 17 days, you're paying an extra $5/month and you can get those movies. They're going to have to advertise that, you know, they have to spend money: "Hey, Hamilton is coming to Disney+."

So I think it's going to shift the marketing budget, it might make it easier to cut your losses, and they might be able to make a decision. Look, Disney is going to know the metric pretty quickly of "If Solo isn't working, do I put it on a paid tier and it's still not going to work, or do I put it on my free tier, surprisingly, every now and then with no predictability? Because you don't want to let people know -- and this is a lesson Disney learned. Disney told us they were opening a Star Wars Land, and people waited to go on vacation. So they're not going to predictably tell you what's going to a paid platform, what's going to a free platform, but they'll once or twice a year, take something that maybe underperforms and shock you with it on a free platform, and that's going to be a driver, but that's going to involve advertising as well.

Hill: So one of the thoughts I had this morning when I was reading this story, because as you said, like, this deal between AMC Theatres and Universal Pictures is the result [laughs] of what happened with the Trolls sequel. [laughs] And this morning, one of my thoughts was, a million years ago there was an episode of Market Foolery where we talked about what -- is it the Hasbro that has, it's either Hasbro or Mattel has the licensing right to the Trolls dolls. And so whichever toy company it was, came out and announced, "We've sold the movie rights to all these toys," and one of them was Trolls. And me and whoever else was on the show that they were just sort of like scratching our heads, like, wait! Trolls, those little dolls with the weird hair, like the neon bright hair, you're going to make a movie out of that? What is that going to do? Who's going to go see them? Who other than very small children is going to see that?

And you know, just add it to the list of things I've said on this show in the past decade that I've been very wrong about, because it's actually the Trolls movie that sets in motion this seismic shift in the business of movies.

Kline: I think this was also a case of timing. And I could argue that if you would switch the release of Trolls and the Scooby-Doo movie, we'd be talking about the success of the Scooby-Doo movie. Trolls came out on that platform at a time when parents with kids that age had just exhausted every option. You had watched everything on Disney+, you played a full game of Monopoly; that's how bored you were. And then Trolls came out, and as a parent, you were like, "Fine, you want to rent Trolls, go rent Trolls." I know at my house, we came perilously close to watching SCOOB! the Scooby-Doo movie. And then we went, wait a minute, there's lots of other movies out there [laughs] that we haven't seen, what are we doing?

Desperation created this. I think this movie, had it come out on the box office, likely would have failed. And if Disney had known, the Pixar film, I think it was called Onward, that got caught in the middle of this; it came out right as the pandemic hit, I think they probably would have moved that first to Disney+ or done it as a tiered release and not put it in theaters. So this was just fortuitous timing for Comcast in a summer where all timing has been awful. Every movie has been delayed or pushed back to the fall or even next year.

Hill: Dan Kline, always good talking to you. Thanks for being here.

Kline: Always happy to be here.

Hill: As always, people on the program may have interests in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear.

That's going to do it for this edition of Market Foolery. The show is mixed by Dan Boyd. I'm Chris Hill. Thanks for listening. We'll see you tomorrow.