Starbucks: China is the core market

Starbucks: China is the core market Editor's note: This article was compiled by Wendy of Huasheng College to provide you with a brief analysis of Starbucks' latest first quarter of 2018...

Editor's note: This article was compiled by Wendy of Huasheng College to provide you with a brief analysis of Starbucks' latest financial report for the first quarter of 2018 and its impressive growth in the Chinese market.

Starbucks released its first-quarter financial report on January 25, 2018. Due to poor holiday sales performance and lower customer traffic in the afternoon and night, the year-on-year increase in store sales was disappointing. However, its long-term growth trajectory remains intact. The company is addressing weak comparable store sales growth and has several plans to accelerate its growth.

>Weak comparable store sales

Although fiscal Q1 2018 revenue increased 6% year-on-year, comparable store sales increased only 2% (see table below), which was lower than the consensus estimate of 3% growth. Sales growth was weak across regions, however, comparable store sales in China increased 6%. The weakness of Starbucks' largest market, the United States, is due to the poor performance of its holiday-limited beverages and merchandise and weak customer traffic in the afternoon and evening. In terms of operating profit margin, the operating profit margin of the U.S. market fell 1 percentage point year-on-year to 23%.

>Long-term growth trajectory remains good

There are still reasons for investors to be optimistic about Starbucks' long-term business growth:

Starbucks is addressing recent weakness

In addition to launching a new food menu and new beverages, Starbucks is also dealing with weak afternoon traffic. The company this year began offering mobile ordering and paid non-points customers, largely solving the problem. In addition, the company launched co-branded credit cards with Chase and Visa in February.

Management also responded to customer needs in the afternoon by sharpening business focus, adjusting staffing and scheduling, leveraging improved daily scheduling and lean techniques, and providing food, beverages and experiences. But the issue may take several quarters to resolve.

Strong growth in China expected over next decade

Despite disappointing U.S. comparable store growth, Starbucks continues to perform well in China. The newly opened Starbucks Roastery and Tasting Room in Shanghai have been well received. Howard Schultz, executive chairman of Starbucks, commented on the newly built Starbucks Roastery and Tasting Room in Shanghai during a conference call:

"Our average weekly turnover at Starbucks stores in the United States is US$32,000. After eight weeks of operation, the Shanghai store has this figure. Double. This is a number that we have never achieved before. Rebuilding the brand and arousing customer interest, we feel that this is not only an opportunity for independent stores in China, but also an opportunity to build special stores in China. "

This store became the highest-selling Starbucks store in the world on the first day of opening. As the middle class grows and is expected to reach 600 million consumers by 2021 (up 100% from three years ago), China is indeed a very large market with strong growth potential. In the first fiscal quarter of fiscal 2018, Starbucks' comparable sales in China increased 6% due to higher transaction volume and a 30% revenue increase. In the first quarter, the company's net income in China and the Asia-Pacific region increased by 9% year-on-year, operating income increased by 20% year-on-year, and the operating profit margin was 23.3%, which was 0.3% higher than Starbucks' US division.

The company also completed the acquisition of East China on December 31, 2017. The acquisition of the remaining 50% equity of the joint venture partner Uni-President Enterprises will make a significant contribution to the future development of Starbucks. East China (Shanghai and surrounding provinces) is one of China's most profitable markets, in fact, the East China business has triple-digit operating margins. The acquisition will expand Starbucks' revenue growth in China over the next decade.

Secondly, there is a huge opportunity for the company to leverage its digital presence in China. Digital transactions increased significantly as the company launched WeChat Pay and Alipay payments. In fact, China's e-commerce and social gifting revenue (such as through WeChat) tripled to nearly $20 million in the first quarter.

Third, China’s channel development revenue still has great growth potential. Starbucks has sold about 30 million Frappuccino bottles since it began partnering with Tingyi Holdings in five quarters. Through Master Kong, Starbucks can sell bottled beverages to consumers who want to enjoy Starbucks beverages at home, at work or on the go. This will further increase market share in China.

Fourth, I believe that with the completion of the East China acquisition and Starbucks' strategy to expand the store scale to 5,000 stores in 2021, the company should be able to achieve better operating efficiency and reduce its sales, management and administrative expenses.

Other positives: Stock buybacks and tax reform

Although Starbucks is still evaluating the impact of the U.S. tax reform bill on its financial statements, the company estimates that its 2018 U.S. GAAP tax rate will be about 23%. They expect fiscal 2018 non-GAAP earnings per share to be in the range of $2.48-$2.53 per share. The company's previous price guidance range was $2.30 to $2.33 per share. The company is expected to return $15 billion to shareholders in the form of dividends and buybacks over the next three years.

>Conclusion

> Although Starbucks' comparable store sales growth was weak in the first quarter of fiscal 2018, I remain optimistic about its long-term growth trajectory. In addition to working to address weak sales growth, the company will continue to focus on product innovation and provide customers with a quality experience. Its business in China is expected to perform well in the coming years, perhaps one day surpassing the U.S. market.

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