Starbucks (SBUX) has been expanding rapidly in China despite aggressively losing business in the country. The new management needs to make tough decisions to help the company get back to winning ways, but there is a good chance the turnaround will take more time than people think.
Starbucks Corporation, a Seattle-based coffee company and coffeehouse chain, is globally recognized for acquiring, roasting, and offering premium coffee beans and brews, complemented with a selection of food items. The brand cultivated its identity through crafting a “third place” experience – a pleasant space incorporating work and home, highlighting top-tier quality, customer service, and community outreach.
The market-leading products consist of coffee beverages, featuring over 230 drinks including brewed coffee, espresso drinks, and seasonal specialties, food items such as pastries and sandwiches, coffee beans, particularly bean and ground coffee, packaged beverages like bottled Frappuccino drinks, and tea products under the Tazo brand. The primary revenue sources are proceeds from retail sales of beverages and edibles at Starbucks locations, alongside wholesale distributors, grocery stores, and other retailers.
The coffeehouse giant accommodates a broad clientele from individual consumers to businesses and institutions. The end market incorporates a range of segments: retail consumers desiring artisan coffee and edibles, corporate clients purchasing for employees or events, and wholesale partners, like restaurants and retail outlets, carrying company products. With a presence in over 28,000 locations all over the globe, Starbucks serves markets in North America, Europe, Asia-Pacific, and Latin America with a modern coffee culture.
Even though having a global business has its perks, it also has its downsides, especially in a tough economic environment. Starbucks is currently experiencing that phase.
Its Q3 earnings showed a 6% decline in US comparable store sales, mainly because people prefer to spend less on luxuries like Starbucks coffee. This decline was more pronounced in China, where comparable store sales fell by 14%. And that is where we believe a big problem lies.
To understand that problem, let’s take a step back and visit the coffee landscape in China. Starbucks has over 7,300 stores in the country. One of its more established competitors, Luckin Coffe, has over 20,000 stores. Cotti Coffee, which was only established 2 years ago, has already amassed over 7,000 stores in the country.
Apart from the above two competitors, there are smaller players that are willing to sell Coffee at cheaper rates. And that’s what matters at the moment. Chinese consumers aren’t the most affluent in the world at the moment. A Starbucks Coffee costs about $4.2 in China. Most other brands sell their coffee for less than $1.5. While it’s true that Starbucks offers a different experience that justifies the premium, the public simply isn’t in search of that experience.
This means Starbucks has to join the price war in China. It is doing that and trying to cover up the reduction in market share through new store openings. In the last 4 quarters, the company has opened up 800 more stores in China.
However, this expansion comes at a financial cost, and the company isn’t recovering this cost from its Chinese operations in the way it would like to. This puts an additional strain on the company.
With a new CEO at the helm of affairs, innovations are underway. The Siren Craft System aims to streamline operations, especially at outlier stores. The mobile order and pay functionality will help non-Starbucks Reserve members manage their waiting times better. New store builds, renovations, and creative cups for the holiday season are some more measures the company is taking.
But all these measures haven’t yet arrested the decline in foot traffic. It seems the company needs more time to get back to its old ways, which is what makes the stock unattractive in the short term.
Starbucks is not on our latest list of the 31 Most Popular Stocks Among Hedge Funds. As per our database, 70 hedge fund portfolios held SBUX at the end of the second quarter which was 69 in the previous quarter. While we acknowledge the potential of SBUX as a leading investment, our conviction lies in the belief that some AI stocks hold greater promise for delivering higher returns, and doing so within a shorter timeframe. If you are looking for an AI stock that is as promising as SBUX but that trades at less than 5 times its earnings, check out our report about the cheapest AI stock.
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Disclosure: None. This article was originally published at Insider Monkey.