6 min read

Starbucks: 25 Billion Reasons for 75 Million Customers to Celebrate

Dear Investor and Supporter,

We wanted to share an important update regarding our investment in Starbucks.

Our fundamental work, combined with a trip to China late last year to observe Starbucks, caused us to exit the name at ~$95 per share. Since that time, the shares fell to $72 as operating performance deteriorated. We used the reset in price, valuation and expectations to re-enter the position, over recent months. Since that time, an activist has also emerged on the register.

Yesterday, Starbucks announced the appointment of a new CEO, Brian Niccol, driving a $25 billion increase in the market capitalisation. Given Niccol’s relentless focus on customer satisfaction in prior rolls, we suggest the 75 million Starbucks rewards members are also cheering today.

Detailed below we outline where the business is, why we believe this appointment to be significant and a pathway to a rerating in the shares.

Operational Context

The U.S. market, Starbucks' largest, is showing signs of strain. Same-store sales (“SSS”) growth has turned negative, with Q2 2024 seeing a 3% decline. This is a significant reversal from the company's historical growth trends. Key issues include:

Declining traffic, especially among occasional customers
Challenges in meeting peak morning demand
Incomplete mobile orders due to long wait times or product unavailability
Increased competition and a more value-conscious consumer

Geopolitical Tensions and International Markets

Starbucks is navigating complex geopolitical landscapes, particularly in the Middle East and China. In the Middle East, the company faces boycotts and negative consumer sentiment due to perceived stances on regional conflicts. This has led to decreased licensed store revenues in the region.

China

Starbucks' second-largest market, recovery has been slower than expected. Q2 2024 saw an 11% decrease in comparable store sales, consisting of 8% and 4% declines in average ticket and transactions, respectively. The company cites macro pressures, changing holiday patterns, and intense competition as key factors. Despite these challenges, Starbucks maintains a strong presence and constructive outlook:

Opened 118 net new stores in Q2 2024
Maintaining double-digit store operating margins for both new and existing stores
Expanded Starbucks Rewards membership to a record 22 million active members
Focusing on premium positioning and coffee-forward innovations

Leadership Change and Strategic Shift

In a significant development, Starbucks announced that CEO Laxman Narasimhan will be stepping down, to be replaced by former Chipotle CEO Brian Niccol. This change comes as Starbucks faces mounting pressure to improve its performance and address operational challenges.

We believe hiring Brian Niccol is incredibly positive as he is one of the best CEOs in the public restaurant sector in our view. He achieved major success at Taco Bell and at Chipotle and is well positioned to do the same at SBUX. We have followed his journey closely over many years.

In prior roles, Niccol has focused on improving the restaurant brand / image, strong menu innovation, operational excellence, and digital transformation. Starbucks has been struggling in each of these areas. Brand image is negative (viewed as too expensive; and recapturing the occasional customer is a key challenge), menu innovation has been seriously lacking (part of the turnaround plan but no big success yet), operations are challenged (the fast paced morning throughput issue is a key challenge), and digital has been good but rewards membership base growth has stalled.

China remains a challenge for SBUX and is not something that Niccol has a lot of experience with. This may increase the probability of a spinoff or franchising of that segment which would simplify the business with a U.S. owned operation and a franchise model elsewhere.

The turnaround process will take time and it is possible that Niccol has to reset earnings expectations lower (that said, consensus has reset to realistic +10-12% EPS growth over the next few years and have long given up on management’s +15-20% target). Furthermore, we expect the market to give the company the benefit of the doubt and look through short term resets.

With Niccol in charge, it is possible to see the multiple return to something in line with prior levels, more quickly than under prior leadership. Per the chart below, the multiple is highly dependent on U.S. same store sales growth. If U.S. same store sales (SSS) can get back to ~3% in the coming quarters (in line with consensus and well below SBUX, CMG, and TB historical comps), we believe the multiple can get back ~24-25x NTM PE. These estimates assume a slow and steady recovery.