long vs short

Long vs. Short: Is Starbucks Still a Good Investment?

A grande mess? Photo: Melissa Hom

The forest-green masters of fast, dark roast, Starbucks has achieved near-impossible growth over the last two decades — worldwide, the number of stores has jumped from around 7,000 in 2003 to over 27,000 as of last month. But 26 years since their initial public offering, the world’s largest coffee chain has faced a tough year, leading to some speculation over whether or not the official baristas of the Fortune 500 can maintain their sprint pace at a marathon length.

In May, two black men were arrested for loitering in a Philadelphia location after the manager called the police, creating fear among investors that young consumers in liberal cities, long their most important clientele, would ditch the chain in protest. Then on June 4, CEO Howard Schultz, who took the brand from Seattle corners to global recognition, resigned amid rumors of a presidential bid. A few weeks later, CFO Scott Maw announced his intention to retire in November. Shares in the company promptly fell 15 percent, before recovering in recent weeks. As of October 11, they were trading at $55, putting a total market value on the company of about $75 billion.

Is Starbucks over-stored, with 13,000 U.S. locations cannibalizing each other in a saturated market? Can the chain sustain its rise without two of its chief officers? To inaugurate our new series Long vs. Short, we heard from two food-industry experts with sharply divergent views on Starbucks’ future: Arthur Dong, a professor of strategy and economics at Georgetown; and Neil Saunders, the managing director of retail at the data analysis firm GlobalData. They spar over whether Starbucks has a bright future in China, and the bumpy road ahead in the domestic market.

BUY

There are three massive growth opportunities for Starbucks that investors aren’t fully appreciating: it’s starting to gain traction among China’s massive and growing middle class, it is breaking a series of smaller international markets like Italy that together add up to hundreds of millions of coffee drinkers, and new forms of distribution that could make its products ubiquitous in home kitchens.

It’s undeniable that the road to growth for Starbucks runs through China. In a culture famous for tea consumption, coffee is catching on fast, and the company expects to triple its revenue in the country and open up 3,000 new stores by 2022. They’re in major cities like Beijing and Shanghai, but haven’t penetrated the market in these secondary and tertiary cities — huge, dense places that offer a perfect opportunity for new franchises. China certainly has a lot of coffee stores, but not necessarily ones that have the brand and distribution that can reach the swelling and newly spendy Chinese middle class.

Starbucks also has a smooth runway in affluent countries like Italy, where they can offer a premium model to differentiate it from mom and pop shops. In a new location in Milan, an espresso costs a little over $2 — that’s double what the local shop might charge, but it’s served in a giant, marble room built in 1901 as the city’s stock exchange. With cocktails and affogato on the menu, Starbucks expects this premium model to crack into Italy’s nearly £6 billion coffee market. More importantly, it shows their ability to adapt to a country’s demands: the Milan Starbucks is much different than their store in Beijing than a store in Midtown. It’s a signal of their adaptability to different markets.

With two major distribution deals this August, Starbucks is positioned to move their ground coffee and packaged drinks into the home in a big way. Their deal with Nestlé, the world’s second largest food and drinks company, allows Starbucks to easily reach all 200 member countries in the U.N. That’s an enormous distribution capability, worth over $7 billion. Then, there’s the partnership with Alibaba in which the e-commerce giant will ship Starbucks goods to over 2,000 stores in China. Alibaba is the powerhouse in China, with a much deeper reach than Amazon’s in the U.S. So if it goes well, this partnership could pave the road for distribution there for quite a while. —Arthur Dong, professor of economics and business strategy, Georgetown U.

SELL

I think we’re at the point where Starbucks is a mature stock. We’re not seeing U.S. growth in new stores, so much as trying to get extra growth out of existing stores by refurbishing them, and activating customers a lot more. That’s a much more challenging environment for growth, one that can’t deliver the numbers we’ve seen from them in the past.

In the U.S. market, Starbucks faces a lot more competition coming from small shops or chains, which are more difficult to understand, adapt to, and then take on. In most markets, the people you’ll find at Starbucks are slightly older, maybe more professional if you like, buying a coffee and leaving. If you go into the niche, independent coffee shops, they’re full of younger people who are spending more money. That’s huge potential for attrition to smaller, boutique stores that can more easily adapt to the needs of young customers. Starbucks handled its PR disaster in Philadelphia fairly well, closing over 8,000 stores for a day of racial bias training. But, considering their general problems with attracting young customers, it could be too little too late.

Starbucks is fighting back trying to reinvent stores, but what people want is a unique experience and Starbucks isn’t in the market to deliver that, compared to independent shops that feel intimate for a younger consumer. Starbucks has its eyes on a 12 percent growth target for the next year, but if they can’t address this issue among its historic base of young customers, we could see waning growth or even a drop into negative territory. —Neal Saunders, analyst, GlobalData

Buyer’s Counterpoint:

Starbucks does face the challenge of keeping young people in stores, considering that the cool factor of the chain is long gone. But, in the U.S., on the macro level, there’s good news: the economy has recovered, unemployment is low, and people have discretionary income for small luxuries. And though in-store sales are important, their partnership with Nestlé with opens up a second major revenue stream. Their packaged goods business, now in its early stages, represents a major opportunity to break into the in-home market–around 50 percent of coffee is consumed at home. That takes time to kick in, but you’ll see results in two quarters or so. —AD

Seller’s Counterpoint:

China is definitely a growth opportunity for Starbucks, and they’re putting the pedal to the floor there. That said, a lot of other brands are looking to expand there, and Starbucks is inevitably going to reach the same position in America: assertive growth, then opposition moves in, Starbucks China matures, and growth retreats. For the near term, it’s a definite opportunity, but Starbucks has to get it right in the U.S., the most massive part of the their business. If such a massive part of the investment goes wrong — think of all the stores and employees and capital invested in American cities — it throws the rest of the business into a bad position. —NS

Long vs. Short: Is Starbucks Still a Good Investment?