Howard Schultz’s departure from Starbucks (NASDAQ:SBUX) comes at a very delicate point in the company’s history. Should a full-blown trade war break out between China and the U.S. it could do serious harm to SBUX stock. Here’s why.
China Is the Future
Starbucks had its first-ever China investor conference in May where it highlighted its plans for the future in its fastest-growing market.
“The power of our brand in China, the strength and momentum in our business, and the world-class Chinese leadership team give me great confidence in our ability to capture the enormous growth opportunities ahead in this dynamic market,” Starbucks CEO Kevin Johnson stated May 15.
Starbucks will open 600 new stores in Mainland China annually over the next five years bringing its total store count to 6,000 spread across 230 Chinese cities. Heck, it’s opening a new store every 15 hours.
At the same time it also plans to triple its revenue and double its operating income in China by 2022 and if results from its newest stores in the country are any indication — they are generating higher average unit volumes and profitability — Starbucks’ future looks promising.
That said, analysts expect China’s same-store sales in the third quarter to be flat, well down from the 8% in delivered in Q4 2017, so even in its biggest market there’s some question marks.
Two Other Things Stand in the Way
The first and more pressing concern as it pertains to SBUX stock is what to do about its slowing U.S. sales. It’s been in this position before and managed to crank up store productivity — Howard Schultz had to come out of semi-retirement — but once bitten, twice shy.
Investors aren’t going to be nearly as forgiving if U.S. same-store sales continue to contract.
Globally, the company expects Q3 2018 same-store sales to increase by just 1%, well below the 2.9% analyst estimate.
“Facing now what is clearly decelerating top-line in its two key markets, SBUX is now saddled with increased EPS risk and a poor recent track record of driving sales,” analyst John Glass said in a note to clients. “We see this stock as range bound, at best, near-term as the catalyst for a US comp recovery remains elusive, offset by a valuation that has been compressing over the past 2+ years.”
The company’s growth plan in the U.S. revolves around two things:
1) Using digital initiatives to continue adding new and existing customers to its Starbucks Reward program. In the last two-and-half months, for example, it’s added two million Starbucks Reward members over the same period a year earlier. That should add 1-2 same-store sales growth moving forward.
2) It’s got too many stores in major cities too close together while other metropolitan areas in the U.S. are underrepresented. Normally, it closes about 50 stores a year; in 2019, it will triple the number of stores it closes. Investors can expect that number in subsequent years should same-store sales continue to underwhelm.
The other problem is China.
The deceleration in same-store sales, while problematic, is likely somewhat transitory and not a permanent situation.
However, should America apply an additional 10% tariff on $200 billion worth of Chinese exports to the U.S., it will be forced to retaliate against American companies operating in China for the simple reason that America only exports $130 billion to the country — eliminating the possibility of a tit-for-tat tariff.
“The Chinese government can organise a boycott very quickly,” said Nicholas Lardy, a senior fellow at the Peterson Institute for International Economics in Washington. “We’ve seen it repeatedly with the cases of Japan and Korea: They whipped up the propaganda machine and suddenly no one was buying Toyotas anymore.”
If this happens you can almost certainly expect Starbucks’ growth plans to come to a screeching halt.
The saving grace in this situation is that Starbucks employs a lot of Chinese workers. The government isn’t going to be keen on punishing its own people’s livelihoods at a time when growth is slowing due to lower exports and a move to reduce corporate debt in the country.
The Bottom Line on SBUX
I’ve been a fan of Starbucks for a long time. In April, I suggested that the company’s moral compass is a big reason to own SBUX stock.
However, given the chill in the air at Starbucks headquarters, not to mention some analysts have lowered their 12-month price targets by 10-20% as a result of the sales slowdown, I do see its stock moving into the $40s over the next 3-6 months barring good news.
Therefore, if you’ve owned SBUX stock for a long time and are sitting on some sizable gains, I’d consider taking some profits and then keeping the proceeds in cash to buy again when the tide turns in the right direction.
If you don’t own SBUX stock, I’d wait to see how far it slides before buying. Long-term, I do think you can’t go wrong with Starbucks.
As of this writing Will Ashworth did not hold a position in any of the aforementioned securities.