International Store Growth To Sustain Revenue Growth Despite Labour Headwinds

Good Coffee Is Instant, Preparation Takes Time: Starbucks’ New CEO Is Just Getting Started 

• The suspension of earnings guidance and low performance indicates that SBUX will need more time to recover.
• I missed the forecasts for the company and am downgrading my revenue estimates from 7.5% to 5% p.a. for the next 5-years.
• Despite low performance, I am maintaining my 5-year profit margin expectation at 13%.
• The new CEO has already started laying the groundwork for optimizing operations from within, which is the right approach in my view.

No Indication For Short-Term Improvement

In Q3 2024 Starbucks reported (1, 2) a drop in revenues of 3% to $9.1B and a global sales decline by 7%. This was driven by a 10% decrease in U.S. transactions volume, leading to a 6% lower U.S. revenue.

On a full-year basis sales declined 2%, but net revenues increased 1% to $36.2B. This is 8% short of my 2024 projection for $39.4B, and increases the top-line growth SBUX needs to achieve to reach my 2028 target from 7.5% to 9.8%. I believe this is an unreasonable growth estimate for a company positioned within a saturated market, which is also experiencing significant headwinds.

EPS dropped 25% to $0.80 per share, v.s. an expected $1.05. For the full fiscal year, EPS was down by 8% to $3.31, which resulted in a net income of around $3.8B. Note that the full-year results aren’t audited yet, so the bottom line may shift. This is a deterioration of profits, which underperforms my $4.7B expected profit for 2024.

The company is suspending guidance for 2025, allegedly due to the change in management. However, Starbucks has a relatively stable business model, and could have easily opted to update guidance throughout the coming quarters. This leads me to believe that they did not want to share estimates about underwhelming growth which the company is likely forecasting for 2025.

Wiping The Slate Clean

• Mr. Niccol, Starbucks’ new CEO is also embarking on a “cleaning house” campaign where he lists some of the failures of Starbucks, while appointing people from his circle of trust to key positions in the company. This is good for investors as it will fast-track the ability of new management to enact changes, and is done in a time where change is demanded from investors, giving its new management a budget to err on the side of overcorrection.
• Management mentions that increasing the range of products and more in-app promotional campaigns failed to improve customer behavior. This admission is a rare type of PR that occasionally happens in a management change scenario, and in this case, it seems that the new CEO wants a clean slate upon which he will build his own record. 
• It seems that in the near future, the company will be focusing on an internal reorganization instead of relying on capex investments to drive growth. This will ensure stable dividend returns for investors despite lower profitability. Once SBUX settles into a more efficient business approach, management will have to re-employ capital in order to drive growth, but before that, it can take some time to drive the one-time efficiency boost that is expected from the new CEO. 
• Management will likely simplify the menu and pricing structure for the business, as it has been an approach that worked for Niccol in the past. The company will also focus on the U.S. region as its key growth and profit driver.
• Conversely, Starbucks China store sales declined 14%, and is further being pressured by increased competition, and a weaker consumer.

What’s In A Cup: Analyzing Starbucks As A Brand

In order to understand the future of Starbucks, I’m going to recap what I think are the characteristics and benefits that made Starbucks an alluring product. 

While Starbucks may seem to be unreasonably priced when seen from a non-customer POV, there are some compelling reasons why the product is sticky:

• Breakfast disguised as coffee - many of SBUX’s products fulfill people's caloric and sugar needs. Especially for people who want to present themselves as eating less.
• Anti-constipation: for some reason, pumpkin-spice latte is magic.
• Status signaling: the large, branded cups are a visible testament showing that people can afford to treat themselves. Conspicuous consumption also manifests itself as a social penalty if a person downgrades i.e. once you start showing up at work with a Starbucks coffee you can’t downgrade without the office gossiping about how “you must have fallen on hard times”. However, one of the few ways to avoid this is if everyone downgrades - which may be happening at the moment.

Additionally, a non cynical view is that SBUX does serve great coffee, is a nice and clean place to relax or be productive in. The pricing structure also selects a smaller portion of people, which de-clutters the seating areas. Unless the hiring manager is working in a labor-constrained environment, they tend to hire young, attractive, and energetic baristas - one of the oldest tricks in the industry.

In summary, Starbucks has a more sticky product offering than it might seem at first glance. However, it does appear that the ever-increasing pricing and weak consumer environment are turning a few defectors into a culture shift, where people are looking to find an alternative way to signal for status. If not managed properly, this can turn into an extended lose/lose scenario, where the brand isn’t as strong, further decreasing the value of the expensive drink. 

The good thing is that the situation can be rectified, and simplifying the business may be a good way to go about it. There is however the question of short-term vs long-term, and I think that the CEO will be faced with taking multiple hits on the P/L in order to fortify the brand, an approach that in my opinion is already approved by the original founder and key shareholders, and a move that investors will ultimately appreciate down the line.

Valuation Implications

For the reasons outlined above, I am changing my 5-year revenue CAGR from 7.5% to 5%, and expect revenues to be around $46.6B in 2029. I expect that a 5% growth rate may feel somewhat bullish at this point in time, but I still see the company being able to drive growth, and the rate is only slightly higher than the expected nominal growth of the economy which is around 4.2% today.

I also remain fairly optimistic in the long-term and maintain my profit margin estimates at 13%, despite the current environment.

This results in my updated net income estimate of $6.1B for 2029, resulting in a $133B forward value for SBUX. Discounted back to today at a 7.6% rate, I get a $93B present value or $86 per share.