Starbucks 2Q numbers - massive China growth

08-MAY-17

At the end of April we had Q2 numbers from Starbucks which missed what the market was hoping for. The result was a 1% drop in the share price, so not a huge miss. Having a look YTD, Starbucks is up 10% when the broader market is up a little over 7% so the company is still doing better than the average. Onto the numbers!

Revenues were up 6%, with Global and US comparable sales up 3% and Chinese comparable sales up 7%. For the US based stores the average ticket price was up 4% but transactions were down 2%, which seems to be inline with the change in the rewards program where value is now rewarded instead of transaction numbers. The number that matters to me is what do margins look like? They managed to grow their operating margin by 40 bps to 17.7%. Thanks to the margin increase they increased operating profit by 8.2%, when this fell to the bottom line, net Income came in higher by 13.5% at $653 million.

Now that the numbers are out of the way, there are two key areas that management spoke about. An area of concern, which was the opening point from the new CEO Kevin Johnson is the state of US malls. Foot traffic to malls is slowing and a number of malls are closing. If people are shopping more online, they are not stopping at Starbucks to get a caffein dose to keep their shopping spree going. On this point Kevin noted that they aren't seeing any significant impact on Starbucks branded stores because the stores are designed to be "destination stores/ experiences". Interesting to note that Teavana (Tea company), which they bought in 2012 is really feeling the heat of the mall slow down. With store upgrades the stores should come right.

To increase the destination offering they are opening up ultra premium stores called their reserve stores, where a coffee sells for around $12. There are only 5 stores currently with another being built in Chicago. Paul did some investigating when he was in Seattle at the end of last year, he said the experience was amazing and that the store is becoming a tourist attraction itself.

The next big theme is their growth in China, where management say you need to actually see what is happening to believe how popular the brand is. Currently they are opening up a new store every 15 hours. China is important because this is where most of the growth is going to come from over the next decade. On a margin basis, China increased margins by 380bps in comparison to the Americas where margins dropped by 130 bps.

Another company that we own, Tencent, has partnered with Starbucks in China. Currently 29% of all transactions are paid with WeChat pay. The easier that you make it for people to pay and for people to gift Starbucks to others, the more orders come through. In the US, including gift cards, 44% of all transactions are prepaid.

Given the huge growth potential in China and the moat created by their premium brand status, Starbucks trades on a premium to other food chains. In our opinion a deserved pricing. Don't expect fireworks from the share price but expect this company to be worth more in 10 years time with a whole lot less shares in issue.