Sluggish Consumer Demand Sets Starbucks Up for Challenging 2024-25

Senior Equity Analyst

Sean Dunlop

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Starbucks is the largest specialty coffee chain in the world, generating $36 billion in sales during fiscal 2023. The firm’s attention to premium-quality coffee distinguishes it from chained competitors, alleviating pressure from quick-service peers and at-home consumption while underpinning substantially higher pricing for what has historically been a commoditized product. This positioning looks increasingly important to us moving forward, as vending, single-serve coffee machines, and quick-service restaurants continue to improve at the lower end of the market, and as China approaches a similarly tiered competitive equilibrium.

While the subindustry has attracted significant competitive attention, Starbucks' cachet has allowed the firm to outflank competitors, leveraging its brand to raise price and mix 8% annually in the US over the past five years, healthily in excess of category inflation. Commanding unit economics, with payback periods in the ballpark of two to three years should pave the way for mid-single-digit unit growth through 2033, in our view, as the firm increases penetration in its core US and Chinese markets, and with its license partners in more than 80 other global markets.

Starbucks' near term priorities, as outlined in its reinvention plan, strike us as prudent: investing in the in-store partner experience, recalibrating stores to better meet the needs of an increasingly off-premises consumer, and emphasizing consistent guest experience across omnichannel touch points. With more than 70% of sales now coming through the firm's drive-thru, delivery, and mobile order and payment channels, augmented attention to back-end systems and throughput capacity are cogent.

Finally, the firm’s ongoing investments in its loyalty program, with roughly 33 million active users in the US, clearly resonate with an audience that has grown increasingly amenable to digital ordering, with roughly 60% of US order volume now driven by program participants. We continue to believe that Starbucks remains a compelling long-term “growth at scale” story, with our forecast anticipating average annual top and bottom line growth of 7% and 15% through 2033, respectively.

Business Strategy & Outlook

Low barriers to entry and minimal switching costs render the restaurant industry very competitive, making it difficult for most operators to develop an economic moat. In our view, firms that are able to do so generally lean into a brand intangible asset or a scale-driven cost advantage, with those sources often arising in tandem. While brand intangible assets are often difficult to definitively quantify, we assess brands based on their ability to generate comparable store sales growth (price, mix, and traffic) in excess of category inflation, carry a banner to international markets, and create value for franchisees where relevant, while cost advantages often materialize through lower general and administrative costs as a percentage of systemwide sales and superior restaurant-level margins.

In our view, Starbucks is one of the few operators in our coverage that boasts a wide economic moat, with brand strength—evidenced by pricing power, attractive unit-level economics, successful international replication, and strong results in the retail channel underpinning a durable brand intangible asset. The firm’s ability to generate excitement and traffic, evidenced by impressive comparable sales growth in the core US market, while spending less on marketing than category peers, reinforces the importance of the brand and its impact on results. Moreover, though we view it as a secondary moat source, we also believe that Starbucks benefits from an durable cost advantage, with its global scale allowing it to procure commoditized food and paper items at favorable prices. The firm’s scale allows it to leverage technology spending across a larger store base, generating efficiency improvements and cost savings through automated inventory management, scheduling, and a robust omnichannel ordering platform, while a strong loyalty program increases its affinity with core customers. Our wide moat rating implies the assumption that the firm can continue to earn positive economic returns for the next 20 years—a view embodied by our 10-year forecast ROICs of 28%, healthily outstripping our WACC estimate of 8.4% during that period.

Considering the firm’s brand intangible asset, we highlight five points that would suggest a strong brand—the firm's pricing power, restaurant-level profitability, successful international replication, strength in the retail channel, and lower marketing spending relative to peers. Starbucks’ position as a premium vendor of coffee, tea, and refresher beverages is widely recognized, as it has historically managed its positioning to avoid finding itself caught between discount competitors like Dunkin’ and McDonald’s McCafé platform on the low end and specialty independent shops on the high end of the market. Strong increases in average check, up 8% per year in the US market since 2019, attest to the firm’s ability to continue to push menu price increases, larger drink sizes, and premium customized beverages (modifiers like an extra pump of syrup or shot of espresso have purportedly grown to a $1 billion platform on their own, to this effect). A US average ticket of $8.99 in 2023, based on Morningstar estimates and Euromonitor data, comfortably outpaced peers like Dunkin’ ($4.39), Tim Hortons ($5.16) and Caribou ($6.88), corroborating our thesis. While pricing power is generally less pronounced in the grocery channel, we note that narrow-moat Kroger's management has identified Starbucks’ packaged coffee and other premium offerings as bellwethers for consumer health in the past, implying that the firm operates at higher price points than other category players, such as Folgers, Maxwell House, and JDE Peet's. 

Pivoting to unit economics, Starbucks' cash-on-cash returns offer one of the highest returns on investment in our coverage for franchisees, with management historically estimating 50% cash-on-cash returns in the US and close to 70% in China. The firm's restaurant margins oscillate meaningfully, but with median North America restaurant margins in the high-teens over the past five years and with average unit sales north of $2.2 million at company-owned stores, we back into roughly $390,000 in average restaurant-level operating profit at midcycle margins—and considering competitive buildout costs (probably around $1 million), given the lack of a full kitchenette at the coffee chain's units, we believe that management's historical estimates are in the appropriate ballpark. We'd estimate a two-to-three year payback figure in the US today, which stacks up remarkably against a QSR industry average of 4-6 years, suggesting that multibrand license partners are more likely to funnel discretionary capital into new Starbucks units than competitive brands with a lower ROI, and generally permits that Starbucks is able to seek out the most reputable and best capitalized license partners in the markets in which it operates—an important undertaking as the firm seeks to maintain its premium positioning and global brand cachet. 

Turning to that global positioning, we view international replication as another pillar of our restaurant intangible asset framework, with strong international uptake and concept portability indicating brand recognition, strength, and product quality. Starbucks operated or licensed more than 20,000 international stores at the end of fiscal 2023, featuring operations in more than 80 global markets. The brand’s reach is matched only by McDonald’s and KFC among chained restaurants worldwide, and potential expansion through the global coffee alliance partnership with wide-moat Nestlé could result in further international opportunities as the consumer packaged goods behemoth has a 190-country footprint. Considering this channel, we appreciate Starbucks’ ability to amplify its brand with premium offerings such as packaged coffees, ready-to-drink beverages, single-serve products such Nespresso pods, instant coffee, and a variety of related items. While the firm saw revenue through this channel decline in each of the last two years, concomitant with more royalty-based agreements, we believe that the firm's long-standing bottling partnership with PepsiCo increases its distribution and manufacturing capability, while the global coffee alliance joint venture has allowed Starbucks to quickly expand into new international markets by leveraging the European firm’s unrivaled network of distribution touch points globally. With distribution and shelf space representing the biggest bottlenecks in the grocery channel, we believe that Nestlé’s entrenched distribution relationships, role as a channel captain, and ability to operate with lower costs as it delivers larger case sizes to retail partners (due to cross-selling) are extremely attractive, while premium shelf placement should see inventories turn faster and in turn become more alluring to retail partners.

Finally, while lower marketing costs as a percentage of sales (averaging 1.1% of sales over the last five years, relative to McDonald’s 4% marketing royalty rate and Dunkin’s 5%) could be construed as a cost advantage, we believe that it more accurately reflects brand strength, as Starbucks has been able to generate buzz and sales volume despite a tighter marketing budget—corroborating our thesis that the firm’s cost advantage is a secondary moat source, subordinate to the strength of its brand intangible asset.

Nonetheless, we believe that Starbucks features a durable and stand-alone cost advantage, with the company’s global scale and strong unit volumes allowing it to benefit from procurement discounts, while strong systemwide sales provide natural operating leverage over fixed investments in technology and product research and development. With revenue of $29.5 billion through company-owned stores around the world in fiscal 2023 (and an undisclosed amount through more than 18,400 licensed stores), Starbucks is one of the largest global restaurant chains, with systemwide sales likely falling somewhere between Restaurant Brands International (we forecast $43 billion in 2023) and Yum Brands ($63 billion forecast in 2023). Only McDonald’s, with $130 billion in 2023 forecast systemwide sales handily outpaces Starbucks’ global reach. As a result, we believe that centralized purchasing allows the firm to take advantage of volume discounts on everything from Mastrena espresso machines to commoditized staples like milk, eggs, syrups, and pastry items, which are subsequently distributed across the company-operated and licensed footprint. We believe that higher unit volumes and proportionately larger drop sizes lower the cost of servicing Starbucks’ stores, allowing the firm to benefit from volume discounts with food distributors and underpinning a durable cost advantage in a category that derives more than one third of sales from independent restaurants. As a final proof point, we consider our estimated $3.1 billion of capital expenditures per year through 2026, against a backdrop that has seen sluggish restaurant traffic and persistent margin pressure—an attestation, in our view, that Starbucks' scale permits investments in moat-accretive investment opportunities through the cycle, ossifying the firm's position as the global category leader during a period in which peers are widely pulling back on nonessential spending.

Further, Starbucks’ scale allows the firm to leverage large technological investments across the store footprint, with a recent focus on artificial intelligence-driven efficiency, yielding a new cold beverage station, a plug-and-play cloud-deployed retail technology stack for US licensed partners, and new equipment for brewing hot and cold brew coffees. Other technological investments, including omnichannel ordering capabilities and the expansion of the firm’s loyalty program have proven fruitful, with 33 million active members in the US utilizing the loyalty program and driving roughly 60% of North American sales volume. The firm believes that loyalty program members spend as much as 2-3 times that of non-loyalty program participants, and storing ordering data on a proprietary platform affords the firm an invaluable database of popular item pairings, promotion efficacy, and even ordering tendencies across geographies, dayparts, and weather patterns. With an estimated domestic customer base in the neighborhood of 75 million (implying penetration of more than 40%), we believe that Starbucks has one of the most widely adopted platforms in our coverage and see strong upside in China and the Asia-Pacific region, where technology savvy customers have more widely embraced mobile order and payment options.

The importance of these technological investments is difficult to overstate. Targeted promotional activity allows the firm to charge consumers different prices without cheapening the brand, while limited-time offers and promotional activity can help drive volumes across dayparts and toward underutilized days of the week or times of day. Marketing campaigns can be measured, adjusted, and deployed in real time, while consumer ordering preferences can quickly offer insights into popular menu categories that garner line extensions and further attention. Proximity to and relationship with customers represents one of the key links in the food-service value chain that cannot be commoditized, and a heightened attention to shifting demand—few would have foreseen cold drinks representing nearly three quarters of the beverage mix, for example—offers a tremendous competitive edge.

Wide

Economic Moat

Starbucks

Teavana is an American tea company. On December 31, 2012, Starbucks acquired Teavana in a deal with an estimated value of $620 million.

Teavana

Ethos Water is a brand of bottled water with a social mission of "helping children get clean water." Ethos water is manufactured by PepsiCo, & Safeway's Lucerne brand, but unlike other Pepsi products, Ethos bottles do not contain recycled plastic. In 2005, Starbucks purchased the company for $8 million

Ethos Water

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Seattle's Best Coffee

Starbucks Corp. engages in the production, marketing, and retailing of specialty coffee. It operates through the following segments: North America, International, Channel Development, and Corporate and Other. The North America segment focuses on the United States and Canada. The International segment is involved in China, Japan, Asia Pacific, Europe, Middle East, Africa, Latin America, and Caribbean. The Channel Development segment includes roasted whole bean and ground coffees, Seattle’s Best Coffee, and Teavana-branded single-serve products. The company was founded by Jerry Baldwin and Howard D. Schultz on November 4, 1985, and is headquartered in Seattle, WA.

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