Stock Talk #12: SBUX Earnings Preview China’s Recovery

SBUX reported Q2 earnings after the bell yesterday (note their “Q2” is Jan 1 – Mar 31). I finished up reading the earnings transcript this morning and my takeaway is that SBUX has learned a lot from their experience re-opening nearly all stores in China that could 1) prove valuable in re-opening US stores and 2) could change Chinese consumer behavior to shift from stay-in ordering to mobile / pick-up ordering, which would be positive for SBUX sales.

The most interesting thing in SBUX’s call is CEO Kevin Johnson’s commentary on sales in China. It starts with his opening remarks:

In China, where the pandemic impacted our business for most of Q2, revenue and comparable store sales declined year-over-year by $325 million and 50% respectively. Today, almost 100% of our stores in China are open, many with limited seating, reduced hours and other safety protocols in place. Starbucks stores that remain closed in China are primarily located in cinemas and enclosed entertainment venues along with international travel hubs and certain tourist zones where restrictions are still in effect.

Since we started reopening stores in late February, we have seen meaningful improvements in China comparable store sales in commercial, residential and office locations. We are also seeing the mix of in-store sales continuing to rise. For the month of April, comparable store sales in China were down approximately 35%, marking strong improvement from a weekly low of minus 90% in mid-February.

Also notable (and one analyst calls this out later) is that others in the food / beverage space like Yum Brands are seeing lesser declines in China. Johnson attributes this underperformance to Starbucks having more concentrated sales volumes in airports and offices, which makes sense as these locations would be more impacted by COVID than stores in less-trafficked areas.

While the company didn’t provide formal 2020 guidance, its CFO, Pat Grismer, had some interesting commentary on China specifically through the next few quarters:

…we are continuing to suspend formal guidance for fiscal 2020, while providing updated outlooks for selected businesses and financial metrics.

I’ll start with China. With the progress we have seen to date including having 98% of our stores open as of today and continued improvements in customer traffic as Kevin mentioned, we believe China’s comparable store sales will continue to improve in the second half of fiscal 2020 relative to the 50% decline reported for Q2, declining 25% to 35% in Q3 and trending towards roughly flat by the end of Q4 relative to the prior year, yielding a decline of 15% to 25% in China’s comparable sales for the full fiscal year.

Here’s my big takeaway – sales back to last year by end of September (recall, their Q4). SBUX doesn’t expect the impact of COVID in China to impact 2021 and beyond, and we could even see improvement in sales year-over-year in the last three months of 2020.

Also, I think it’s worth reflecting on SBUX’s prediction that sales could swing from -25-35% to flat quarter over quarter. This is actually a commentary on how quickly behavior will adjust to the pre-COVID norm. SBUX is saying “after you re-open ~100% of stores, we think it takes 2 quarters to get back to normal”. This bodes positively for the US, as the prediction here is that the COVID impact should be over by the beginning of next year.

Johnson also notes that the US actually isn’t that far behind China, as the expectation is nine out of ten stores will be open by June:

This is the beginning of the recovery as we reopen stores, beginning in early May and we expect to have approximately 90% of all company-operated U.S. Starbucks stores reopened by early June with enhanced safety protocols and modified schedules.

Finally, it’s worth noting that SBUX management does provide some reasons that a direct US-China comparison isn’t fair:

– The US has a larger portion of mobile pick-up and drive-through customers, but also in management’s eyes won’t be able to lift COVID-based store restrictions as quickly as in China.
– The US stayed in under its own lockdown for six weeks, whereas China’s was closer to three
– China gradually lifted restrictions on a city-to-city, even community-to-community type basis. While re-opening might be faster for the US, it may also come with more restricted re-opening measures (ex. drive through only, store capacity limits)
– Per Roz Brewer (COO) “China is a sit-down market and the U.S. is a grab-and-go market“

Notably, Kevin Johnson did say COVID could from a revenue-perspective positive change habits for Chinese customers, causing them to shift orders from stay-in to to-go / mobile

Just real quick on China. Traditionally we’ve seen 80% of our business be stay-in and enjoy their drinks in the cafes. As COVID hit, we hit a peak of nearly 80% of transactions being digital orders. And those digital orders were all set up with the contactless experience through walking in the stores and picking up your orders in Mobile Order & Pay. And then the rest of it was delivery… if there is a silver lining, I think it is forming a new habit in China, where you are seeing more people take to-go orders and get used to doing that.

Overall, I think the SBUX call was on the whole positive – management seems to think a China sales recovery should be complete by year-end and that US stores will be completely re-open (with a marketing blitz to follow) by the summer, albeit in a modified form. The balance sheet is strong and the company isn’t cutting the dividend.

As is the norm for the post Corona world, I’m obligated to caveat that management said there’s a ton of uncertainty:

On balance there are just too many unknowns and too many moving pieces to be able to provide more explicit guidance on Q3 results outside of China at this time other than to say that the impacts to revenue and operating income will be much more substantial in absolute terms in Q3 [BB’s note – again, this is April – June] compared to Q2, but we do expect these impacts to moderate in the fourth quarter. And we will continue our practice of providing updates to the investment community when we have better visibility to them.

I’m a proud SBUX shareholder and I’m encouraged the company is on pace to re-open US stores and expects sales in China to get back to flat by its Q4 (end of September).

There are a lot more calls to take in this week (AAPL I’m particularly excited about today). I’m going to continue to look for more calls like this that give us a sense of how recoveries might play out.

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