Starbucks (SBUX 0.47%) investors had some big concerns heading into the company's fiscal 2022 third-quarter earnings update (for the quarter ending July 3). The coffee giant has been losing market share to rivals like McDonald's (MCD -0.91%) as consumer preferences shift toward drive-thru and on-the-go ordering. Starbucks' value proposition has traditionally stressed the in-store experience, making it hard to see how the company can thrive in this new selling environment.
The chain's early August earnings update didn't erase those concerns. Customer traffic is still weak in the core U.S. market and plunging in China. But stabilizing sales trends suggest it might not be long before Starbucks returns to a more offense-oriented growth posture.
Let's dive right in.
Growth trends improved but work remains
Starbucks' sales trends are positive, though not yet up to management's targets. Comparable-store sales in the U.S. market were up 9%, compared with a 12% increase in the prior quarter. That translated into a new sales record and surpassed the 4% comps uptick that McDonald's posted in late July.
Still, Starbucks achieved almost all its growth through higher prices, with customer traffic edging up by 1%. The company has been working on making its stores more responsive to today's coffee fan, who is increasingly using pick-up, drive-thru, and delivery options.
CEO Howard Shultz said that the strategic shift is starting to help the business but that plenty of work remains. "We have a clear line of sight on what we need to do to reinvent the company," Shultz said in a press release.
Profits are down
The chain's earnings power was hit by the combination of inflation and the increased spending on the business. Starbucks also saw pressure from a 44% sales slump in China, where pandemic-related lockdowns temporarily reduced customer traffic.
SBUX Cash from Operations (Quarterly) data by YCharts
Non-GAAP operating margin fell to 16.9% of sales from over 20%, despite higher menu prices. For context, McDonald's notched a slight increase in its industry-leading profit margin this past quarter. Starbucks is still a cash-generating machine, though operating cash flow over the last nine months has declined to $3.3 billion from $4.5 billion.
Looking ahead
The good news is that Starbucks executives see some encouraging signs about their growth potential. Demand for beverages and snacks is strong across most of its global selling footprint, meaning worries about a quick recessionary slump appear overblown.
Yet the main fog hanging over the stock is uncertainty about the timing of its growth rebound, and shareholders didn't get more clarity on that point. Starbucks is still declining to issue a fiscal-year outlook because of factors like unpredictable demand swings and accelerating inflation.
And while the pressure from the China market will ease as it returns to normal operations, Starbucks might still have more than a year of elevated spending ahead on upgrading its stores to better handle mobile order pickups.
There is a good chance that these strategic shifts will help return the chain to the market-beating sales and earnings growth that shareholders were used to seeing from Starbucks in the pre-pandemic days. Yet investors appear set to endure a few more quarters of rocky operating trends before that rebound path becomes clear.
