Login ID:
Partner Login
Contact Us : 7066511911

Starbucks Teaches Silicon Valley a Lesson in Tech -- Barrons.com

19 Aug 2017 4:01 am
By Alex Eule 

There were plenty of reasons for skepticism when Starbucks rolled out its digital ordering system nationally in September 2015. EBay had already rolled out a location-based system that recognized customers as they walked in the door. Consumers were not particularly impressed; eBay eventually spun off its PayPal unit. Apple Pay, meanwhile, was launched in 2014 as a faster, more secure method of payment. Merchants weren't enthused. Many never activated the feature.

But Starbucks (ticker: SBUX) was still betting that its customers would jump at the chance to preorder coffee and food for pickup at a nearby store.

Sure enough, the company's mobile order-and-pay feature has become a major hit, one more example of Starbucks' -- and coffee's -- universal appeal. The preorders have actually created bottlenecks at Starbucks' counters, as pickups collide with in-store orders. The company is rethinking store layouts and hiring preorder specialists to handle the demand.

In the latest quarter, 9% of Starbucks' U.S. orders were placed in advance. Moreover, nearly a third of all Starbucks' orders were paid for via the company's phone app. The numbers are remarkable when you consider the Apple (AAPL) comparison. Today, even in stores where Apply Pay is available, barely anyone is using it. Given the opportunity to check out with Apple Pay, only 5.5% of iPhone users actually choose the option, according to the latest research from Pymnts.com. Starbucks has changed consumer payment behavior in a way that should inspire envy in Silicon Valley.

ON WALL STREET, though, sentiment for Starbucks has become lukewarm at best. The coffee giant's shares have fallen 18% in the past two months. At a recent $53, Starbucks is trading at its cheapest valuation level in five years.

The culprit is a slowdown in same-store sales, a measure of success for a retailer's existing store base. Starbucks recently expressed caution about the current quarter, as well. Investors, who are usually quick to blame companies for shortsighted thinking, are now the ones being myopic. The stock could recoup its recent losses, gaining 20% or more over the next 12 months.

Starbucks identified the smartphone revolution years before most bricks-and-mortar firms, and the technology still holds big promise in boosting sales over the long term. "The kind of growth and financial performance we are seeing out of customers with whom we have digital relationships blows the socks off of anything Wall Street would possibly want to see," Matthew Ryan, Starbucks' global chief strategy officer, tells Barron's.

During a conference call last month, Ryan told investors that the company's digital efforts "make it very challenging for digital companies to outmaneuver us in the physical world. While digital companies may win in other sectors, we will be the digital company that wins in ours."

The clear message: We're not waiting around like everyone else for Amazon.com (AMZN) to take our business.

THE BIGGEST INVESTING STORY of 2017 is the destruction of value in the retail sector. Just last week, shares of Dick's Sporting Goods (DKS) fell 23% after a weak earnings report. Coach (COH), the iconic fashion brand, tumbled 15% on its results. As Amazon's market value has soared by $105 billion this year, the rest of the Standard & Poor's 500 Retailing Index has shed $22 billion. A narrative has taken hold: Bricks-and-mortar outlets just can't compete with digital competition.

Investors are quick to react when that story line gets confirmed: Witness the broad selloff for all things retail on the day that Amazon announced it was buying Whole Foods Market (WFM) for $13.7 billion.

But the stock market isn't sure what to do with the exceptions. It often punishes companies that spend money on their own digital transformation. While Amazon trades mainly on its future promise, investors don't give traditional retailers the same benefit of the doubt, even if they've made big progress on the digital front.

Take Nordstrom (JWN), whose shares have fallen by nearly half in the past two years. The department store had $3.2 billion worth of online sales last year, and its e-commerce business has grown 20% annually in the past three years. But because the numbers have not yet translated to total sales growth, investors have sold off the stock.

Starbucks is now stuck in a similar situation, as sales growth has slipped from stellar to simply better than average. Its global same-store sales were up 4% in the latest quarter, which still beats restaurant peers. Of the 36 restaurant companies that have so far reported results for the period, the average same-store sales gain was 3.1%, according to Thomson Reuters I/B/E/S. In the Americas region, where 61% of Starbucks 26,736 stores are located, same-store sales were up 5%, bested only by Domino's Pizza (DPZ), Chipotle Mexican Grill (CMG), and a small company called Del Taco Restaurants (TACO). (Chipotle's number was inflated, coming off a weak year due to food-safety issues.)

STARBUCKS INVESTORS have gotten used to even better results, though. The fear now is that the company will pull back on its long-term guidance, which currently calls for annualized profit growth of 15% to 20% through 2021. The company plans to update its 2018 guidance in the fall, but the bad news is most likely already in the stock.

For the current fiscal year ending in September, analysts expect Starbucks to earn $3.02 billion, or $2.06 a share, up just 8% from a year ago, with sales growing 5.6%, to $22.5 billion. For fiscal 2018, analysts see earnings per share growing 14.6%, with revenue up 10%.

Starbucks is trading at 23 times projected earnings, the stock's lowest price/earnings ratio since 2012 -- and well below its five-year average multiple of 27. The company's growth has always earned the stock a significant premium to the broader market; over the past five years, it fetched a P/E of 1.7 times the S&P 500 multiple. That relative multiple has come down to 1.3.

"I do think the rerating in the multiple reflects expectations of lower growth going forward," says Sara Senatore, Bernstein's restaurant analyst, who still rates Starbucks an Outperform. She now uses a relative multiple of 1.5 times for Starbucks' stock to arrive at a 12-month price target of $67. That's still a gain of 27% from the recent quote.

For Starbucks, the mobile opportunity is about driving loyalty and higher spending per customer. For now, at least, mobile users are required to sign up for the company's free rewards program, called My Starbucks Rewards. MSR members are an important group for the company.

While they represented just 18% of Starbucks' 75 million customers last quarter, MSR members accounted for 36% of sales. Ryan, the company's global chief strategy officer, points out that in the latest quarter spending per member grew 8% from a year ago, double the rate of the company's global same-store sales.

"You can do the math and see why we're so enthusiastic about digital relationships," he says. Starbucks is already pushing personalized options to its digital customers. Regular coffee drinkers who occasionally order an egg sandwich might get 50 stars if they also try a latte.

Ordinarily, customers get two stars for every dollar they spend, which is tracked automatically by the app. For every 125 stars, customers get a free drink or food item.

Next up, Starbucks wants to grow the member base and offer more personalization, with triggers like weather and time of day. That might spur a discount on iced coffee during a heat wave, for example, or an afternoon Frappuccino if it's not otherwise part of a customer's routine. "The ability to incentivize around specific things that our customers want and that are good for our business becomes the secret sauce going forward," Ryan says.

TO SAY THERE'S A STARBUCKS on every corner is only a slight exaggeration these days. Earlier this month, Starbucks was downgraded by one Wall Street analyst who worried that the company's ubiquity had become a handicap. Find one Starbucks store, and you'll now find 3.6 more stores on average within a one-mile radius, BMO Capital Markets noted when it downgraded Starbucks shares to Market Perform from Outperform, up from 3.3 stores in 2014. The stores are largely clustered in urban areas. In New York City, for example, there are 24 stores in that one-mile radius.

Has Starbucks finally reached saturation? The answer is a matter of perspective. BMO argues that new stores are now cannibalizing old ones. But Bernstein's Senatore says new outlets remain economical. She estimates that new U.S. company stores pay for themselves in 16 months.

Ryan, meanwhile, says it's still "an absolute no-brainer to open stores, " based on the data the company has. "I wish I were just allowed to open all our books to show what we know here."

While Starbucks has captured a 64% share of the specialty-cafe market, 70% of all coffee is still consumed at home, according to Bernstein data. All told, Starbucks is responsible for just 5% of Americans' 400 million daily cups of coffee.

STARBUCKS THINKS IT CAN POUR a lot more of those cups, in the U.S. and overseas. The company plans to have 37,000 stores worldwide by 2021, up from around 27,000 today. About 40% of those new stores will be U.S.-based. Some 5,000 are slated to open in the Asia-Pacific region, a 70% increase in the company's presence there.

Some of the stores will have an entirely new look, too. Starbucks plans to build flagship roasteries across the world and 1,000 reserve stores, which the company says will help further elevate the brand. The reserve coffee fetches as much as $10 a cup. A few of the stores have already opened in Seattle and other big cities, and Starbucks has begun adding reserve bars to some existing stores. In 2019, the company plans to open a four-story cathedral of coffee in Chicago.

(MORE TO FOLLOW) Dow Jones Newswires

August 19, 2017 00:01 ET (04:01 GMT)

Copyright (c) 2017 Dow Jones & Company, Inc.
Top 5 Special Reports
CBoT Soybean Reaches 4-Months High on Dry, Hot U.S. Wea...
Weekly: Masoor Falls On Overseas Supply, Chana Dips As ...