We have all been reading about the challenge that Brian Niccol has taken on at Starbucks. An article from Business Insider, dated 9/3/24, hit my desk this morning. Below are some highlights.
A Starbucks worker of nearly 20 years says the chain has gone from ‘quirky coffee shop’ to ‘soulless fast-food empire’
- Starbucks is at a crossroads as Brian Niccol, is set to take over this month.
- One longtime employee said Starbucks has become more like its fast-food rivals.
- Working at the chain has changed a lot since the mid-2000s, the employee said.
“…for one North Carolina Starbucks worker who has spent 19 years at the company……it used to be a great place to work…..people wouldn’t leave Starbucks unless they were college students and went up into a higher career, or they retired with the company.
“…..the switch, from Laxman Narasimhan to Brian Niccol comes as Starbucks faces slumping sales in the US, long customer wait times, and challenges in China…..
“The employee, who started working at Starbucks in the mid-2000s, said the company had a reputation for treating workers well when he joined. But he said changes over the past couple of years, such as cuts to staffing levels at his store and an increasing stream of mobile orders, have changed that image.
“The Starbucks location where the employee works now has two or three people on duty most shifts, down from up to five a few years ago, he said. That leaves employees more stretched, especially with a constant stream of orders placed through the Starbucks app, and less time to serve customer who order in-store.
“it started out as a trendy, quirky coffee shop job, and it’s just morphed into this soulless fast -food empire since that time,”
“Ever since Howard left….things have just really gone downhill…..after Schultz stepped down as CEO in 2017.
“Wall Street analysts have lauded Niccol…..but the Starbucks worker in North Carolina isn’t as optimistic. He told Business Insider he’s skeptical that Niccol will address the problems….including a chronic shortage of worker hours and the surge of mobile orders that tend to overwhelm the employees on duty.”
WE SAW MOST OF THIS COMING, GOING BACK 7-8 YEARS AGO, AND PROVIDED CHAPTER AND VERSE AT THE TIME. The most telling fundamental facts since then, are:
Earnings from continuing operations have declined, from $4.518B in the Y/E 9/18 to $4.124B in Y/E 9/23.
Diluted EPS has gone from $3.24/share to $3.57/share, solely because shares were reduced by 15%.
SBUX stock has done very little over the last eight years. After maintaining its momentum from ’16 to ’18,, going from around $60/share in ’16 to about $100 by late ’18, SBUX has done nothing since. Selling today at $92/share, even from the $60 level of ’16, the 53% move over eight years is less than 6% compounded. It is also worth noting that SBUX traded at the current level, in the low 90s, exactly five years ago, so there has been no appreciation during that period.
WHAT HAPPENED? Almost exactly our concerns of 2016-2018.
AS WE WROTE:
STARBUCKS – Great company, still, but stock will continue to underperform
STARBUCKS (SBUX) – Great company still, but operating earnings are flat, and stock is expensive. Always has been expensive, but growth in earnings and cash flow is not what it was.
Introduction:
We have written a number of articles over the last two year, with excerpts provided below. We have consistently expressed our admiration for this worldwide brand, at the same time pointing out that the “easy money” has been made. We think it is no accident that the stock has done nothing since late 2015, in a trading range from the low 50s to the low 60s. While adjusted EPS increased from $1.58 in the year ending 9/30/2015 to $1.91 in fiscal 2016 and $2.06 in ’17. It is timely to re-examine our thesis, as the stock trades toward the high end of its two year trading range, during which it has underperformed the market, we believe with good reason.
On August 2, 2017, I wrote an article describing the changing business model at Starbucks, including the possibility of unintended consequences.
THE TIMES THEY ARE A’CHANGIN’
BARRON’S MAGAZINE this morning has a front cover entitled THE FUTURE OF COFFEE (AND RETAIL). The subtitle reads “Starbucks has succeeded where Silicon Valley hasn’t: changing the way consumers pay. The behavioral shift holds big promise for the coffee giant and its stock”.
Not exactly, in my opinion. It is not just about “the law of large numbers”, and the difficulty of satisfying investors by building on profit margins that are well above peers. The business model has changed, and the question becomes whether the new model will match the original. It’s well known that a new loyalty program bothered some customers and also that an increasing number of customers are ordering and paying online, often in advance of entering the store. In the most recent quarter, 30% of US transactions were paid using the smartphone app, up from 25% a year earlier and 20% two years ago. More important, to my view, is that 9% of US orders were ordered and paid for in advance. The company has been discussing the store level congestion for several quarters now, as mobile orders slow down service for customers going through the line. Perhaps it’s just me, but I am put off somewhat when the line at the register (where I like the human contact) is short, but I have to wait while eight or ten orders are pumped out ahead of my own.
MILLENIALS, WHO ARE THE SPENDERS, DON’T VALUE HUMAN CONTACT (AS MUCH)
It’s not so long ago that pundits dismissed the internet as a retail venue. The public was not expected to give out their credit card information, and certainly was not going to buy “touchy, feely” products like apparel or shoes through online channels. The public is not only ordering “everything” through Amazon and others, but relationships are maintained through Facebook and other social channels. As a corollary, customers are increasingly seeking “experiential” retail situations, rather than visit the malls, with their undifferentiated stores and restaurants, most often staffed with poorly trained employees.
WHAT’S IT ALL MEAN TO EMPLOYEES, AND CUSTOMERS?
Relative to Starbucks, their leadership with mobile order and pay, increasingly in advance of the store visit, may well be appropriate and necessary, but the business model has changed. It’s become a production challenge, not a relationship driven enterprise. The employed “people person” who was the star of the previous model, is not going to be as easily satisfied, because most of the employees, for most of their time, are busy pumping out product. It’s going to be harder to find someone as described previously who says that Starbucks “is making me a better person”. From the customer side, there are 27,000 stores already existing that are already tightly configured and can’t be reconfigured too much to handle a lot more production. From a customer standpoint, some, like myself (perhaps in the minority these days), who value the human contact, may decide that the local independent shop, or even the home or office kitchen, can provide an adequate cup of coffee at a competitive price without the “tumult”.
CONCLUSION
I remember when Howard Schultz said that food will never be a material part of Starbucks’ sales. Today, it represents 30% of revenues. Schultz originally envisioned his coffee shops as a “third place”, to hang out other than home or office. That’s a little hard today, in a small busy shop, but we can call this an “unintended consequence” of building one of the still growing premier worldwide brands. Comps and traffic have slowed in recent years, due to the “law of large numbers”, the natural limitations of small stores that were not originally built to handle today’s volumes, and the evolving environment that every successful retailer must adjust to. Starbucks is one of the most successful retailers ever created, and we don’t doubt that they will continue to succeed in a major way. We caution however, that the rate of progress demonstrated in the past, already slowing, will be increasingly difficult to replicate. The business model has evolved. Starbucks was a retail “disrupter” but their previous approach may not be quite as successful. Accordingly, valuation parameters that have applied to SBUX equity in the past may not apply in the future. The stock chart that has languished over the last couple of years may well be reflecting the most likely future business model; still good, just not quite as great.
Lastly, on January 4, 2018, we wrote:
This is a very big ship, forced to navigate a continuing turbulent, competitive consumer spending environment. Growth in sales and earnings has slowed, and we doubt that EPS growth can be re-ignited, in large part due to the law of large numbers. To some extent, SBUX has become a “cash cow”, very profitable, generating still very high returns on capital, even if the base is growing more slowly. The shareholder base is transitioning to include long term value, and dividend, oriented, investors. In fact, SBUX has been in a trading range from the mid-50s to the low 60s over the last two years, with the stock’s valuation mirroring the slowdown in earnings (and EPS) growth. The corporate initiatives described below, further described by management on their conference call, are all necessary for further progress. Collectively, they can maintain corporate progress, and even move the growth rate by a few points, but we suspect that the days of high single digit comps (in the US) and 20% or better EPS gains are in the rear view mirror. There are now a large number of operational moving parts, not all of which will proceed smoothly. Furthermore, the business model is evolving, with possible unintended consequences, as discussed in our report of 8/22/17. Earnings reports in 2018, as predicted by management, will be muddied by one time transactions, so “adjusted earnings” will be a feature of their reports. Analysts and investors may not care much, if the current forgiving stock market environment continues, but tolerance for lots of adjustments will not be as high if the general market runs out of steam. A revised food menu is in the works but, even if food sales increase, non-coffee margins are lower, so earnings may not “leverage”. Starbucks is a great company, and will remain so, admirable in many ways, a great brand building example. The Company is one thing, the stock another. Investors can, and will, decide for themselves, what valuation is appropriate.
WHERE DOES STARBUCKS GO FROM HERE? AS OF 9/4/24
We believe the conclusion just above, written almost seven years ago, in early 2018, applies just about as well today. Brian Niccol is a talented, experienced and highly successful restaurant executive but a fleet of 40,000 stores worldwide is a pretty big ship to turn.
Roger Lipton