Starbucks Corp. (SBUX, Financial) reported fiscal second-quarter earnings on April 27 that exceeded Wall Street's estimates. The company, however, missed revenue projections by 1.4%. Shares fell 3% after the earnings announcement on concerns regarding its growth potential in international markets, but the reopening of the economy is expected to help earnings growth in the second half of the year.
The popular coffee chain is in a strong position to gain market share once the mobility restrictions are eased and restaurants are allowed to offer dine-in options globally. Starbucks shares have gained 42% in the last 12 months, but there is more room for upside over the next several years.
Second-quarter earnings recap
The company reported fiscal second-quarter revenue of $6.7 billion, up 11% from the same period last year, and net income of $659 million. The U.S segment saw strong comparable growth from -5% in the first quarter to 9% in the second quarter, and revenue from this region reached $4.7 billion. Customers ordered larger, more expensive coffees and added food to their orders this quarter, increasing the average ticket by 21%.
The international segment reported revenue of $1.6 billion, which was a strong 34% year-over-year increase. The channel development revenue was $370 million, down 29% from the previous year mainly due to the adverse impact from the Global Coffee Alliance transition-related operations, which included a structural shift in a single-serve platform (Nespresso and Dolce Gusto) and additional product sales to Nestle S.A. (XSWX:NESN, Financial) in 2020 to transition foodservice order fulfillment. Nevertheless, the Global Coffee Alliance has now expanded into 71 markets around the world. As a result, Starbucks is welcoming more customers to its stores than ever before in densely populated international markets.
Starbucks' partnership with PepsiCo, Inc. (PEP, Financial) drove a 23% increase in the consumption of ready-to-drink coffee products in the U.S. as well.
In China, same-store sales increased 91% year over year, and the reopening of the country played a major role in this growth. The easing of pandemic-related restrictions and improved customer mobility in the residential, office and commercial trade zones played an important part in aiding Starbucks' growth. The company was able to expand its customer base by allowing consumers to place orders online and pay through WeChat and the Starbucks app.
The company strengthened its digital customer relationship through its Starbucks Reward Program as well. The digital expansion program has already seen massive success in China, mainly as a result of the rising middle-class society in the country. Starbucks also launched its flagship store on JD.com (JD, Financial), offering merchandise, store value cards and seasonal food. The company added 110 net new stores in China in the last quarter and recently announced the opening of its 5,000th store in the country as well. The company is well and truly tapping into the lucrative opportunity available in this East Asian nation.
Starbuck is embracing sustainable policies
On April 6, the company announced a decision to eliminate disposable cups from its cafes across South Korea by 2025. Starbucks will launch the "cup circularity" initiative in July to serve beverages in reusable cups. The company has taken this initiative after the South Korean government revised a set of laws to reduce the use of plastics and disposable items.
Starbucks also announced its "Borrow a Cup" program, under which customers can order a beverage in a reusable cup with a deposit of $1 and receive in exchange a credit and 10 bonus stars after returning the cup. The company partnered with Ridwell, a company that provides home pick-up service for recycled products, to offer consumers an easier way to return their borrowed cup.
If these initiatives achieve the desired results, Starbucks is well positioned to roll out these sustainable policies internationally, which should lead to an increase in valuation multiples as investors seem to be keen on attaching a premium to companies that are making progress in adopting enviornmental, social and corporate governance policies.
The outlook is promising
Starbucks is preparing for a full recovery from the 2020 lows by modernizing its market leadership position based on the current consumer sentiment and buying habits. The economic recession and the pandemic have reshaped consumer preferences in many nations, which is something the company is planning to address in the second half of the year. CEO Kevin Johnson highlighted five notable developments that could help the company gain traction in the coming months. He said:
"Customers crave human connection. They have been longing to be together again face-to-face, feeling part of a community. This is human nature and has always been central to Starbucks ' experience. Second, they are looking for convenient, personalized experiences that effortlessly fit their lifestyle. Third, customers appreciate consistency, knowing what to expect at each visit. Fourth, customers seek out high-quality offerings that support the well-being of the planet and society. And finally, customers are increasingly looking to support brands with strong values, values that are demonstrated by actions."
Starbucks is well placed to benefit from improving household spending in the Asia-Pacific region and growing coffee consumption in Latin America as well. Both these regions could help the company report better-than-expected earnings in the next couple of quarters.
The success of the loyalty program will also be a catalyst for growth. Active Starbucks Rewards memberships reached 22.9 million in the United States duringe the most recent quarter, and the company continues to achieve new milestones. According to surveys conducted by many market research companies, a widely accepted loyalty program has the potential to increase the brand value of a company and to increase the number of returning customers.
Commenting on what the future holds for the company, Johnson said:
"There are many reasons to be confident and optimistic about the future for Starbucks. Personally, I am optimistic about the back half of this fiscal year. But even more importantly, it is clear to me that the actions we are taking, the customer and partner response we are seeing and the focus and discipline we have brought to the business have clearly positioned Starbucks for the next several years of growth."
Industry outlook
According to data from Mordor Intelligence, the global coffee market was valued at $102 billion in 2020. It is expected to grow at a compound annual rate of 4.28% between 2021 and 2026. Europe dominates the industry, with higher per capita consumption and a shift toward a premium coffee culture. The global demand for coffee is increasing due to the cafe culture in European countries and the growing number of coffee shops in the United States and Asia. Although the industry was not spared from the wrath of the Covid-19 pandemic, the current trends show coffeehouses will see a significant increase in demand once consumers feel it is safe to go out.
A survey conducted by the Institute for Scientific Information on Coffee found that 68% of surveyed individuals prefer to have coffee while working. The return to the office, therefore, is likely to result in an uptick in demand for the global coffee industry as well. According to the Global Coffee Market Report (2021 to 2026) prepared by Research and Markets, the Asia-Pacific region is expected to be the fastest-growing for the industry. This growth is being driven by factors such as increasing disposable income, the rising popularity of the coffee culture, a rise in the number of cafes and increased demand for premium cafes.
Latin America accounts for 60% of coffee production worldwide. The ready-to-drink market in this region is valued at $4 billion, which is expected to grow at an annualized rate of 22% over the next five years, presenting an opportunity for leading coffeehouses to expand their business in the region. Starbucks is taking advantage of this growing market trend by partnering with PepsiCo to launch ready-to-drink beverages in Latin America.
Takeaway
Despite its size, Starbucks is still a growth company. It is aggressively pursuing the opportunities available in international markets through menu innovation, strengthening of the loyalty program and investing to improve its digital presence. Once the company successfully penetrates its target markets, Starbucks is likely to distribute the bulk of its excess earnings to shareholders via dividends and buybacks.
Even though the company is valued at a forward earnings multiple of 40, which is significantly higher than its closest peers, this premium valuation is understandable because of its market leadership. Starbucks is well-positioned to report earnings growth in the future, and shares are still trading at very attractive territory for growth investors.
Disclosure: The author owns Starbucks shares.
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