So, Daniel, how would you recap the slowing growth story that Atlas Research outlines in his article?
DS: I think it's — there are two main points, I think, which is the U. That their new stores seem to be cannibalizing their existing stores, which is most evident in their traffic. Their traffic is really — I think the author compares it to the recession era, as far as the last time that they generated consistent flat or negative traffic growth on a year-over-year basis. I think that's been for a period of about a year or so. The author has a chart showing a steady growth in the store count contrasted against steady decline in same-store sales growth, which is especially hitting them because of lower traffic growth.
Food traffic is down and that is the — I think the crux of it. And then the other sort of big point is that China — the author doesn't see China as a real growth opportunity for Starbucks at this point. And so, you don't have the overseas growth story that Starbucks has been telling for a long time, and you have the fact the company has overbuilt itself in the U.
You know it was founded, I think, some 30 years after McDonald's, and so, it's just interesting to see that contrast. MT: I kind of glommed on to the domestic side of things. It looks from just Googling around that our global sales are still pretty small relative to domestic sales for Starbucks. So, I — that was my assumption going in and looking at it, it seems to be more or less the case. So, my first question is, kind of, okay food traffic declined one or so percent for couple of years now, are we sure that that's — how bad do we think that is?
I just didn't have — for one thing — one thing that jumped out at me was they compared Starbucks with McDonald's and they show Starbucks in a downtrend of the same-store sales. So, the same revenue from stores that existed a year ago, how did those compare? Basically, trying to get a clean measure of how — within a given store what's the sales picture look like?
And the point that author Atlas researchers was trying to make was that McDonald's has risen to become sort of the Number 3 player in coffee and they now offer many drinks that are comparable to Starbucks drinks and they are sort of computing.
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But I also noticed that from to , same-store sales are down for both McDonald's and Starbucks. So, I'm wondering whether this is an issue that's specific to Starbucks or whether it's a broader issue. And on top of that, I'm wondering whether these metrics matter. So — and I would start with food traffic, so what do you think?
Do you think this is Starbucks specific? And do you think food traffic is a really important measure of success? I think same-store sales is ultimately where you want to make your bones. So, yes, actually I don't know if your question leads me to think that you disagree, but I do think traffic is probably the more important of the two.
I think share pricing power is great, but part of the argument the author makes is, and this is also where McDonald's comes in, is that on the high side, Starbucks is facing more and more competition from — Blue Bottle was an example they used, but from these sort of chic-ier, actually — in some cases actually local coffee, high-end coffee shops and in other cases just other coffee shops, other chains, and then on the low-end, you just have competition from Dunkin' Donuts DNKN or Dunkin now from McDonald's from whomever else.
I think the fact that people are gunning for them makes sense, and should be counted — factored into the valuation, but I also don't know how new that is or how surprising that is or anything else. MT: Okay. I guess I mean that I'm going to take a risk of mischaracterizing the argument here, so if I — if this is because I don't understand some of the terms or I don't understand the metrics properly then so be it just.
So, Starbucks is raising prices and food traffic is declining. I think the author mentions drug use for example, but I wonder if that's actually — all those things are kind of — you could tell a story where that's all kind of by intent.
So, Starbucks is positioning itself, kind of, as an accessible premium coffee brand, then one thing that it might do is create a, kind of, be theoretically open to everybody than have systems in place that create the kind of environment that they still want, pricing being one of those. Do we know what kind of customers those are? So, are we necessarily sure that — I just think that you could pokes a few holes in the food traffic declines as being negative, meanwhile sales are still increasing.
They are increasing slower but they're still increasing. So, is the food traffic a leading indicator of sales? This is very persuasive and then I've come — become a little bit more circumspect about the author's interpretation of the growth slowdown. DS: Let me make a one chart that I thought was compelling and then also move into one of the other topics you wanted to get into, just management. The thing — the chart that I found the most impressive, and the author has a lot of charts, they put in themselves based on the company filings. Specifically, you don't — you want to see a restaurant company gaining operating leverage and gaining traffic, obviously, you want them to be — more people to be coming in, and that's again, where we get into okay, where are we with Starbucks?
You see it everywhere, you know, I live in Europe, you see it everywhere; it's very common; and they even entered Italy finally. So, the question is what else — where else can Starbucks go? Are they mismanaging or anything else? And that's where in the management point, the thing that I found was interesting, I think, were two things.
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One more compelling circumstantially, don't know how much matters, especially given the other point, which is that the author quotes the management team, then COO, Kevin Johnson, who is now the CEO, and former CEO, Howard Schultz, when he was the CEO, and points out how much they try to argue that slowing comps were not a big deal in There were anomalies, he quotes — the author quotes Howard Schultz saying that in 24 years of public life, can't remember anything like Q3 , which was the run up to the U. Presidential Election, but also a fairly dramatic statement in hindsight.
MT: Schultzy, baby.
He did — just real quick on this, like he dipped his toes in the political waters and like this is fairly self-inflicted, right, like he was complaining about the level of political discourse in America in the context of the Republican primaries. DS: Yes. In other words, there's still some transition from the old regime to the new regime, which when a new management team comes in that has an impact on what the company is going to do their strategy, and then how it plays out in their stock and everything else.
So, I think that's an interesting angle here. I'm actually little bit skeptical about — you know I'm thinking about the recent tweet from the J. Morgan JPM account about the bank account telling its client that if they just didn't buy coffee every day, they would have a lot of money and that sort of thing or whatever it was, but Suze Orman also said something, but I think —. Rich people are cheap, they get rich by being cheap.
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Morgan tweet. And I think if you look at that break down, a lot of those elements were not really — may have been considered non-essential in a previous economic regime, but I think the way we are constituted now, a lot of those things are sort of requirements or they can be viewed as investments in ways to advance like get better wages or get better jobs. But I also think I mean come on, lot like the idea that discipline on everyday small purchases doesn't have an impact on long-term savings and well-being is I think a little over blown.
You can only become an investor if you sit. DS: I — no, I hear that.
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I think my quick take on the tweet is that it was just in bad taste the way it was delivered. It was very sort of snarky and very — very clear that it is your fault rather than trying to remind that, yes, frugality can get to somewhere, and coming from a bank like J. Morgan, which has been put in the spotlight for couple things like it's not always — J. It's — than McDonald's for example.
And Starbucks, I think, is the same way. I think people — it does have brand power is what I'm arguing. So, where am I going with this? Revenue is going up, but then it is incrementally thinner and thinner contribution to operating earnings. Like you can go in and get — if you just want to a coffee, you can go in and get it, but you can also go in theory there and set up your laptop and work or meet a friend and catch up over coffee, which is something that I think people would not do so often in Dunkin' Donuts kind of the color scheme in there is very orange and pink and it is seems to have that sort of McDonalds get the teenagers out of the store fast food type of design aesthetic where Starbucks has a kind of — tries to be just like more dark for a screen and has lighting a little bit less harsh and tries to be a place you can actually go and hang out.
DS: Be careful about how you refer to Dunkin' Donuts my friend. It is a…. I love Dunkin' Donuts. I love the coffee. Shout-out to my celiac listeners. So, I think that is the other, there is the operating story, but I am also interested in the financial arguments. They are trading at something like 30 times. Mostly related to transaction integration related items, but also some persistent restructuring and stock-based compensation. And the author kind of ties that back to management incentives, which were tied around that which was a fair point.
Anything you see in that part of the story before the buybacks thing, anything you see in the terms that they are adjustments, their non-GAAP stuff or anything else noteworthy about our management efforts here? Starbucks' most important tool to generate sales growth over time has been to expand the number of stores. Source: Annual Report The target for net new Starbucks stores for the fiscal year is set to 2, In Q1 , the company reported a total of net new stores. By extrapolating this to the fiscal year , assuming the same growth rate, the company's current run rate is 2, new stores.
This is also a target that is under the direct control of the company, which further strengthen the belief that it will be achieved for this year. The same-store sales show a clear picture of the long-term success factors for Starbucks and how the growth is sustained. Changes in transactions have slowed down significantly in all regions, and some regions are in a long-term decline.
Sales growth has instead been driven by a change in ticket and not by a change in transactions. Operating margin was down slightly, but in line with the target. This was primarily driven by higher wage and benefit-related investments in its store partners employees. Operating margin declined more than expected for the first quarter, driven by the impact of the ownership change in East China in Q1 The development in the EMEA segment was challenging for Starbucks, with declining comparable store sales and significant negative operating margin development.
This was mainly driven by unfavorable foreign currency translation. It will be challenging for the company to achieve its targets for this region. It is very likely that the company will continue to be driven by a change in ticket rather than a change in transactions. The strong brand equity of Starbucks and loyal consumers give support to the pricing argument. Starbucks remains a very solid business with strong durable competitive advantages driven by a vast store network and a strong brand name. Based on the historical development and its results YTD, we believe that Starbucks will manage to deliver its targets for fiscal year With this said, we also see clear signs of the business entering a phase of slower growth, taking into account the long-term trend in change in transactions and slower growth rates in some of its regions.
An investment in the company is starting to appeal more to investors seeking a growing and reliable dividend income rather than those seeking to invest in a company with high growth. With Starbucks' strong FCF generation and historical dividend growth, we believe the enterprise has plenty of room to continue to increase its dividends long term.
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In our book, this means that it is priced for perfection, and any missteps will result in a lower share price. Current investors that have a long-term investment horizon and seek reliable and growing dividends are recommended to remain invested in the company. New investors that look for a growth company are likely to find other, more appealing investments at this time.
Short-term investors are recommended to sell their shares in Starbucks, as it is unlikely that the stock price will continue to go higher this year.
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