Starbucks Corporation (SBUX) Earnings Call Transcript & Summary

Great. Well, thank you everyone for joining us today. I'm Andrew Charles. I'm TD Cowen's restaurant analyst. I think today's session really needs no introduction. Starbucks is the largest roaster and retailer of specialty coffee in the world with more than 36,000 stores spanning 80-plus countries. I'm pleased to be joined by CFO, Rachel Ruggeri; and we also in the audience have VP and Head of Investor Relations, Tiffany Willis. And so Rachel, thank you so much for joining us today.

Thank you. Thanks for having me.

I want to start the conversation talking about your new CEO, who's been on the job now for 70 days following a 6-month apprenticeship with Howard. You guys laid out the reinvention plan at the September Investor Meeting. And so really curious about which parts of the plan is he leaning most into? Where has his focus been the most in the last 70 days or so?

Sure. So Laxman has come in and he's taken a look at the reinvention plan, and I would say he's expanded it. And so we're focused on 5 areas which really focus on elevating the brand, which means running great stores, which is really the foundation of the reinvention plan. In addition to that, it's continuing to drive our leadership position in digital and continue to find ways to scale by bringing in more new and relevant experiences for customers. In addition to that, it's becoming more global, both for our brand and our business. I think there's sometimes a misunderstanding that all about our growth is China, and it's really our International segment. That's a big driver of our long-term growth algorithm. So even our markets outside of China. And so it's becoming more global in terms of our brand and our business as well as a focus on reducing waste and improving overall productivity and efficiency, not just from a financial standpoint but also because it creates a better experience for partners and customers. And then finally, it's all about reinvigorating the culture. And I think all of those together is how we're thinking about moving forward and continuing to evolve the company while we continue to elevate the brand.

Excellent. So let's start digging to the business domestically. So first on digital, where you guys are really amongst the most sophisticated, most advanced in the industry. We're encouraged by a record number of 31 million active Rewards members that continues to drive record percent of tender. 2 years ago, you made reference to ultimately reaching 50 million Starbucks Rewards members. And so really curious about what are the key unlocks to get to this point? And do you see potential upside beyond 50 million members, just given the program success in recent years?

Well, we're incredibly pleased with our digital program. We consider it -- we're leading in this space. It's a competitive advantage for us. And to give you a perspective, while we're pleased with the 31 -- close to 31 million 90-day active members we had in the quarter, today, we have about one in every 10 U.S. adults as a Starbucks Rewards member. So that's a good statistic, but I see a lot of opportunity in that. And so when we think about how do you further that opportunity, believe it or not, one big opportunity for us is to continue the awareness. There's still a huge opportunity just in terms of awareness and having always-on marketing. There's an opportunity to continue to improve the perceived value of the program while continuing to make it easier to sign up. And so some of the things we've done more recently with MOP, for example, is we've changed some of the practices so that it makes it easier to order. And we know that customization and convenience are key attributes to MOP and our MOP customers, and that increases habituation. We recently launched our Rewards Together, so our program with Delta. So it allows Delta Rewards members and Starbucks Rewards members to continue to earn through the different loyalty programs, and that creates a perceived value and actually a real value for our customers. And then even Odyssey, you hear a lot about Odyssey, and we're one of the few companies that's been able to integrate NFTs with a leading loyalty program. And there's benefits to customers like the journeys and the ability to buy the paid NFTs. But really, what it does for us is be able to create a digital community. And so it allows us to be able to create that opportunity to connect even outside the 4 walls of our stores. So it's a true third place digitally. So those are the ways that we continue to find value, and we believe that will help us to capture even share of wallet in the future.

Excellent. The long-term reinvention plan that you laid out in September, some very exciting elements around automation via equipment upgrades. And I know there's about 12 pieces of equipment that are coming in that will fit like a jigsaw puzzle. And so not to go through each 12 of them. But what I guess I'm curious about is just at a high level if we zoom out, can you remind us kind of the time line around when you anticipate the key amount of legwork will be done around the equipment upgrades? And when you anticipate the investments will wane while the benefits presumably drive operating leverage? So I know we talked before about your 15% to 20% operating EPS growth from '23 through '25. Is the right way to think about that, you'll see kind of a ramping, if you will, kind of as that work unfolds?

I think the way to think about it is our reinvention plan is sort of always ongoing when you think about -- the idea is to elevate the brand by running great stores. We're always going to be having to work on how do we run great stores. And currently, what we're focused on as part of reinvention is the stability of the operating environment. That's through the right staffing and the right scheduling and the right hours for partners and the right training, coupled with optimizing our production environment, and that's where the equipment comes in. And so equipment is critical to be able to make the production environment less complex and to be able to unlock capacity, but it has to be supported with the stability of the environment. And so what we've been doing is investing, as you know, and what we saw more recently is those investments start to amplify. So we start to get the benefits and we start to see the amplification. We saw that in the most recent quarter, where our business in North America grew at 17%. We were able to expand margin 200 basis points, even though we're continuing to invest. And so that idea of driving strong performance, it unlocks the capital that we need to continue to invest in our stores, our partners and our customers and will support durable growth. So that's the way we think about these investments and these investment rollouts. And it's in particular to the equipment, Siren System, which is very complicated. It's the biggest overhaul we've ever had in our production engine. I never know exactly where to look. I'm looking at Andrew and then I kind of look at across. But it's the first time we've overhauled our production environment in over 50 years. And it's got a lot of complication in the sense that it's multiple pieces of equipment. It's multiple small wares. And it takes a significant amount of training for our partners. It takes a significant amount of focus on repairs and maintenance, but it's a significant unlock, the Siren System, both the food side and the beverage side, a significant unlock in terms of really optimizing our production environment, which will support the long-term growth that we've talked about.

Yes. And Siren System, yesterday, I know you hosted a group meeting. You talked about how less than 10% of the system will have Siren System in 2023. Roughly, we'll get to roughly 50% -- I'm sorry, less than 10% by 2024, mostly through new stores, some retrofits, then obviously, the big retrofits begin kind of in 2025. We will get to roughly 50% by the end of 2025. So I think how do you balance, if you will, the speed that this is the right solution, it's a great unlock for the partner, a great unlock for the guest in terms of the speed of service benefits you're going to get with the fact that being gentle around operations, that this could be disruptive, so wanting to be more deliberate about that? So could you talk about kind of the how you marry the art and science around that?

Yes. And I would say, first and foremost, is we would expect maybe less than 40% by the year 2025. And the reason for that is it's largely rolled out through new stores as well as renovations. And so the thought around that is you're able to leverage the cost in a new store because the new stores have such strong returns and we're able to be even more targeted around where is the best place to open new stores. So you're able to put that investment in and still drive the business even though you're investing significantly. And around renovations, it's the ability to take that renovation, which was planned for a certain amount of downtime. And then you're able to further expand the return on that renovation by driving the system that's going to significantly grow sales as well as overall profitability. But it's the pacing and sequencing that's really important because it is such a big unlock, but it also can be quite disruptive because the amount of change management involved. And so we're ensuring that we're coupling moves like Siren System with a lot of other moves around creating a more stable environment, having the very best operational practices and standards, having the very best partners in stores and ensuring they get the hours they need and the schedules they need. And the combination of all of that allows us to continue to invest over the long term while we continue to drive revenue and earnings and create this more durable growth.

Very good. One of the keystones of the September investor meeting was long-term guidance for 7% to 9% U.S. same-store sales in excess of the roughly 4% to 5% prior guidance pre-COVID. So can you talk about kind of your confidence now in achieving that over the long term versus the guidance that was issued 9 months ago?

Yes. Well, certainly, you become more confident every month that goes by and every quarter that goes by. But when I think about that 7% to 9% in the U.S. for this fiscal year, a big driver of that is the pricing moves that we took last year, which are annualizing. So that gives us more confidence that that's an annualization of ticket. But in addition to that, we're continuing to see growth in customization, we're seeing continuous growth in mix, some more cold beverages. And that helps drive the comp. In addition to that, we have the growth in the digital program. And our increased number of Rewards members -- when members join the program, their frequency increases and so too does ticket. And when they actually join MOP, frequency increases even further. So all of that helps us drive more ticket and transaction. The combination of all of that is what gives us the confidence in the comp range.

Got you. Two more questions on the U.S. It's important to separate Starbucks' check growth in recent years. That's largely a function of mix growth from all the stuff that you -- all the work you've done to really help premiumize the brand. Iced beverages, digital and food attachment rather than price, which you guys have been very deliberate with as well. So I guess my question is that if we were to see a softening restaurant industry sales environment, where would you expect to tactically lean in to help preserve traffic without degrading the brand and all the work you've done on premiumizing?

Yes. The fact that we have a leading digital program is really an advantage for us. And we have the opportunity to continue to evolve that, as I shared earlier, around creating new and relevant experiences for customers. And when we think about the very best marketing vehicle we have today, it's the digital program and it's our connection with our Rewards members. So if we were to see the business soften in some way or the pressures that come with some of the headwinds in the current environment right now, one lever that we can always pull is continuing to be able to speak directly to those customers. We can market directly to them. We can create experiences that are more meaningful and relevant. And that allows us to continue to keep the brand elevated while we focus on a particular targeted revenue growth.

Excellent. I want to switch gears to China, which I recognize is one international market you have, but I would categorize as your most important one market that could be bigger than the U.S. one day. And so in the most recent quarter, the China business certainly came back faster than expected, improving in March to a very impressive up 30% comps. And so while China is in early stage of recovery and you're about to lap some very easy compares, you forecast that the pace of upcoming China improvement is expected to be more modest, and this was obviously before the most recent COVID wave over the last 2 weeks that the country is suffering through right now. Can you just expand on kind of the thoughts you had around the earnings, around that philosophy, around kind of what you were guiding to with China? Did the comments reflect kind of one month of slowing improvement in April? Or perhaps you're looking to just take a more kind of conservative outlook because of China's nonlinear performance the last 3 years amid what was, obviously at the time, unknown but what we're seeing today to be a COVID wave?

I'd start by just saying we're incredibly pleased with the performance we saw in Q2 in China. And that was driven by a sundry of different factors. But really, it points to the fact that we have a market-leading portfolio. We have an increasing omni-channel capability and we have a leadership position as it relates to coffee and a very strong brand, a leadership position in terms of frequency and visitation. All of that supports strong growth for us or puts us in a position of strength as we think about the growth that's to come. But I think as it relates to recovery, which we are -- even though we're in a great position to recover, we are dependent on consumer behaviors and behaviors normalizing. We saw that in every single market. U.S. went through a period of recovery. We're seeing even benefits today in our license business as we continue to see recovery. And so China goes through -- is going to go through that as well as we're seeing. So when we spoke in the quarter about the moderation, it wasn't relative to comp. We actually expect our comp will improve in the back half of the year, particularly as we lap Q3 prior year where we had the mobility restrictions. And so we expect our Q3 comp to be higher, of course, than what we saw even in March. And the back half of the year comp will have to be stronger to be able to hit that low to mid-single-digit comp that I guided for a full year basis. The moderation was relative to average weekly sales. So we saw our average weekly sales in the market in Q1 to Q2 grow by near 20%. We expect that they'll continue to grow in Q3 and Q4 as the business recovers, but just not at 20%, so maybe something less. It could be 10%, it could be 13%, but it's not going to be 20% in terms of our expectations, but it's still growing, which I think is the key message. The point that I also want to make though that sometimes gets lost in a lot of this recovery is that China, in terms of a comp weighted on international, is typically about 70%. And because of the mobility restrictions last year, our revenue for China last year was about 46% of international's total company-operated revenue last year, which is a proxy for what comp weighting would be this year. So that means the Q3 comp this year is closer to a weighting of about 46%, where previously and historically, it's 60% to 70%. So that's something that's unique about the quarter as we think about the lap. That isn't a comment on any subsequent quarters or any quarters in the future. That's really relative to Q3.

Got you. Just through arithmetic, I got you. Okay. And then looking ahead, how does the impact of increased China coffee shop competition factor into the slope of the sales turnaround, this long-term guidance for 4% to 6%? Obviously, when you have a business that has high returns, yes, you have a moat, obviously, around digital. But obviously, anyone can start a coffee shop in China, of course. So how does that factor into your long-term guidance?

Well, definitely, the market in China has changed over the past couple of years, and the specialty coffee market has grown. And what's good about that is we're in a great position because we're in a position of strength. But you see an increasing consumption around coffee. So coffee consumption is increasing. And so that's a good position for us. And when we think about what that means for us over the long term, where we've continued to focus and where we've strengthened as a business, we believe, puts us in a position of strength even with all of the competition. So we've continued to open stores all through COVID and that gives us a market-leading portfolio that allows us to not only capture new occasions but brings in new customers. In addition to that, we have this increasing omni-channel capability, which is really new in the past, I'd say, 2 to 3 years. So prior to COVID, our digital was about 15% of our business collectively. We were closer to 47% last quarter. And so that's growth in delivery. That's growth in MOP. That helps drive a morning occasion and a new daypart for us. And we also have this ability now from an omni-channel capability to leverage social media as a way to bring customers into our stores. So that's a significant, I'd say, new driver for us and creates new channels of convenience that will help support growth in the future and lends well to that 4% to 6% comp we've talked about. In addition to that, we have a very strong brand, as I talked about just a minute ago. And that's the reason why we see such great loyalty from our customers, and that was evidenced in the fact that even in the last quarter, we saw our 90-day active members near record high. And they were about 68% of tenders. So we have strength in that loyalty program that we have as well as a coffee leadership. And one of the things I'd say about China that's also unique is we have an incredible partner base. So we have low turnover, we have high engagement, and we really have incredible partners. And when you put the combination of all of that together, it gives us confidence that we'll be able to recover this business, but more importantly, it will continue to be a strong driver of our growth in the future.

Super. China, of course, carries tremendous operating leverage in the model, just given its 100% company operated. And you mentioned the business will unlikely get back to pre-COVID margin levels on a percentage basis, just given the material level of growth and low-margin delivery. So I guess I'm curious about the opportunities to offset that margin drag, just given the company historically didn't really emphasize China margins, if you will. I mean are you exploring supply chain enhancements, expanding in lower-tier cities where wages and rents are lower or just other opportunities to really lean in your scale a bit more?

I would say we're always looking at opportunities to further our margin expansion. But when you think about the market in China, when we talk about the fact that we don't expect to see our margins return to pre-COVID levels, that's really because of the mix shift towards digital. Delivery is still a strong margin business for us, but it has a lower percentage than an in-store experience. But what's important about delivery and specifically digital is it allows us to drive more revenue and subsequently more profit. So even though we'll see a lower margin percent, we'll still see greater revenue and greater profit. And that's what drives the higher comps that we spoke about just a moment ago. What I will point to, though, is our International segment, we expect we can get back to pre-COVID levels from a margin percentage in our International segment. And what's important about that is that relies on the recovery in China, but it also speaks to the growth that we have in our international markets outside of China. What we point to is the fact that outside of China, we have incredible revenue headroom. We have partners that are really willing and able to invest with us. We have strong unit economics, and we're increasing our digital capability. And so that allows our International segment to continue to grow even outside of China. So you couple that with the recovery of China, and we expect that our margins in the segment will return to pre-COVID levels over time.

That's very helpful. Thank you. Just last question for me on China. Can you talk about what you're observing with the unit economics for the newest class of China openings? Typically, China sales volumes open at low volumes and then ramp. Have there been any aberrations with the newest class of openings' sales volumes, so that slope of sales growth, if you will, in year 1 and year 2?

No, we actually have been incredibly impressed with the performance of our new stores, even all the way through COVID, which is why we continue to open. When you step back, it's really about the unit economics that you can drive. It isn't about store count. And so the fact that we've been able to see the strong unit economics has given us the confidence to continue to open stores. And that's why we continue to open all the way through COVID. And even in this last quarter, we doubled openings so that we ended the quarter with over 6,200 stores across 244 cities. We see that as a competitive advantage for us in many different ways, again, because it brings in new customers and it creates new occasions. And so because of that, we still see a 2:1 investment turn, and we also see a strong payback. And so we'll continue to open stores as long as those unit economics prevail. And as they do, we'll continue to get to that 9,000 stores that we talked about by 2025.

Very good. Keeping with development, you highlighted also a 2:1 sales investment ratio for the U.S. stores as well as in China, translating to 50% cash-on-cash returns. And so what's kind of interesting is the breadth of the different type of openings, different store formats that you have in the U.S. going forward. And so can you help us kind of rank the unit economics between your 3 U.S. store formats of traditional drive-through, drive-through primary and, call it, kind of the other formats, if you will?

Let's start with our portfolio today. We have over 9,300 stores in U.S., and I'm focusing on company-operated only, not including licensed into this. And we have about 70% of our stores today are drive-through, about 29% are cafe, and then we have about 1% that are pickup. And of course, the strongest economics are in our drive-through. But it's important to be able to have stores that meet customers for different occasions and different reasons. And so pickup is a perfect example of that. It doesn't have the unit economics that are quite that of the drive-thru, but it meets a customer need, and it helps with overall demand. And so when we think about our opportunity in the future, it's how do we leverage our portfolio to unlock capacity but also in a way that best meets the customer needs and demands. And so that's going to be different versions of drive-through stores. It's going to be delivery-only stores as well as different versions of pickup stores. So a lot of different, what I'd call, store designs and types to be able to meet the increasing demand that we see.

Yes. You kind of tackled my next question, but I'm kind of curious on more of the new store formats that you're exploring. So delivery-only is interesting, digital-only, doubling drive-through. So I think that would be kind of a key opportunity for you. Like I know sometimes, you see partners with iPads taking orders, but maybe that's an opportunity as well for you guys. AI voice ordering at the drive-through is something at the conference we've been exploring a lot as well. Do either of those sound something like -- something that Starbucks could pursue?

Yes, we're currently in test. We have, as you talked about, our purpose-built designs. And really what that's about is to be able to elevate the experience by creating stores that not only unlock productivity, but they best meet the type of demand. So when we talk about a delivery-only store, as an example, when you look at a store today, it has -- you can go to a store that has all the channels. It has a drive-through. It has MOP. It has delivery. It has an in-store experience. That can be complex. And it sometimes doesn't create the best experience for a customer, and it's certainly challenging for partners. And so when we talk about a delivery-only store, we see a path towards that in the future as delivery is becoming a more and more meaningful part of our business. And so we look at delivery only as a way to take the complexity out of the existing stores, and it creates a better experience for both the partner and the customer. Drive-throughs, we look at like a drive-through-only model where you might have a lane that services drive-through and a lane that services MOP as an example. That's for a very highly [ virtual ] type of customer. It may not be right for a customer like me who likes to walk into the store, but it's ways to be able to use the store design to elevate the experience for the customer and also at the same time, taking into account what it means for the partner.

Very good. A couple of questions I just want to ask you. At the investor meeting, you guys issued 2023 through 2025 annual EPS growth of 15% to 20%. The message at the investor meeting was that this was going to ramp in '23 through '25 with 15% indicated for 2023. And so I guess as China has kind of rebounded -- back in September, obviously, zero COVID was in full effect. It is not today. But as China has moved out of COVID with obviously some near-term noise but just more of an opportunity with zero COVID going away, we talked about the tremendous momentum in the U.S. business. Is there anything that would lead this anticipated '23 through '25 ramp in EPS growth to dematerialize?

To dematerialize?

Yes, dematerialize. Not coming to fruition.

Yes. What I would say is we're encouraged by what we're seeing in our North America business. So that was evidenced in the last quarter where we've been on this journey of investing and part of the reinvention for a little bit now. And this last quarter was really a good testament to the fact that our strategies are working, and so we have a lot of opportunity ahead. And so we're encouraged by what we see in our North America business. Clearly, China, we've talked about the strength of China and the competitive advantage we have, but there is a dependency on recovery. And so it's hard to know exactly how the consumer behaviors will normalize. We see a business in international outside of China today that is benefiting from a different customer behavior than what we saw pre-COVID. As an example, Japan and U.K., we talked about in our last earnings update. Japan and U.K. are at double-digit comps for the eighth consecutive quarter. That is new relative to COVID because we've been able to open more drive-throughs. We've been able to open in more suburban areas. And so we've seen the customer behavior shift, and we've been able to meet that. So that's created more opportunity and strength in our international business outside of China. So I think with China, it really depends on where the recovery will come and how soon that it comes. But I think when I look across all of those areas and opportunities, and then you look at our channels business, right, and our ability to continue to be able to amplify the brand and grow through -- basically, they have seasonal moment opportunities in grocery stores. We have opportunities with new flavors and innovation in RTD. I just look at that universe, and you always have to be mindful of the fact that there's going to be headwinds to come. But I feel pretty confident that we're on the right path with even those 5 strategic areas that I spoke about that Laxman is helping us focus on that I think will create that business resiliency that will help support the long-term growth over time.

Excellent. Okay. So good to hear that's still kind of on pace, obviously, just keeping an eye on China. But it sounds like, obviously, the slope is still there and still something that obviously, you intend to execute on. So that's very helpful. Rachel, we talked a little bit about this. I want to put a finer point on it. That the 2022 Investor Meeting, probably the biggest difference from the 2020 meeting is that Starbucks seems to want to keep the company on markets other than the U.S. and China. And so what's driving that decision? As naturally, it's easier to streamline your focus on fewer company-owned markets rather than more? Is it the strength in international markets that you guys have seen over the last 2 years or so that gives you confidence?

I think that's exactly it. It's what I spoke about. Since COVID, we've seen strength in some of our markets like Japan and U.K. and our other international markets outside of China that didn't exist in exactly the same way pre-COVID. And so what it's given us line of sight to is there's a lot of growth opportunity and growth potential. But what I'd say is we just want to have flexibility in terms of how we consider our ownership decisions, and we'll continually always assess that and we may make moves over time that are contrary or maybe they do go to licensed, maybe we do. But I think the flexibility of being able to assess our ownership structure is important as we think about how we grow in the future.

Yes. Just on that, so totally get Japan, obviously, is a very big and profitable market for you guys. But if I think about some of your low to no growth markets that you are seeing, obviously, an improvement in same-store sales, but the runway for growth perhaps isn't as lucrative as some of the other markets. I'm thinking of the U.K., I'm thinking of Canada that have historically underperformed. What would you need to see for those markets to potentially license them? Obviously, we're going to start with having a great partner, but what other factors should we consider for?

It definitely comes down to, first and foremost, you have to have a great partner and the right partner. And part of being the right partner is that you align with the values of the company, that you align with the growth objectives that we have. And so those are some aspects. We've been very successful in a lot of our markets internationally. We have very strong partnerships. And those partners have worked well with Starbucks. They understand our values. They support our values. They run in a very similar manner and they're great operators, and that's helped our growth. And so I think it really comes down to that as a team to be able to find. But then you also have to make sure that the business is strong enough to be able to be attractive as well. And so we've seen that growth more recently in some of these markets, but it's consistency that really drives that over time.

Yes. My last question in 1.5 minutes that we have left. U.S. competition, we've seen -- if I go back 6, 7 years ago, it was more about the third wave, artisanal craft coffee shops that were coming up. Today, in 2023, it's more on the drive-through-based coffee shops, very much focused on specializing in iced beverage. And so just given your strategy focused on drive-through and iced beverages, do you worry about the more competitive environment going forward?

I think competition is always important because it keeps you sharp. And so competition is -- it also shows that there's opportunity. And so we look at that opportunity and we try to focus on what is our competitive advantage. And for us, we believe the competitive advantage wholeheartedly is the experiences that we can create in whichever way a customer comes to us. So whether it be through the drive-through, whether it be through digital, whether through an [ import ] experience, delivery, it's creating the very best experience. And whether that be through product, whether that be through convenience, all of those different opportunities are the way that we set ourselves apart. And we're on a journey. We've gotten it right for a very long time, but we have to continue to evolve. And I think we've shown that our reinvention plan helps support that. We have great opportunity in the future. So I'm actually encouraged. Laxman uses a phrase that says, we have limitless opportunity, and I truly believe that even after all these years.

Super. That's all the time we have. Rachel, Tiffany, thank you guys so much.

Thank you.

Thank you everyone in the room.

Thank you.