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Morningstar | Menu Innovation, Digital Engagement, and Store Simplification Efforts Position Starbucks for Growth

Starbucks carried much of its momentum into fiscal 2019, with simplified store operations, improved digital engagement, and a stronger beverage assortment driving solid U.S. comps (up 4%) and delivery and digital efforts helping the company to weather a still-competitive China coffee landscape (China comps increased 1%). While there is additional work to be done with respect to the customer experience in both regions, we believe the operational, menu, and digital engagement changes Starbucks has implemented in its two largest markets--coupled with new go-to-market strategies through the Global Coffee Alliance (GCA) with Nestle--have stabilized the brand intangible asset underpinning our wide moat rating and should keep the company on track to meet--and likely exceed--the long-term goals it outlined at last month's investor day event, including 3%-4% comps (3%-4% in the U.S. and 1%-3% in China), 6%-7% net new unit growth (3%-4% U.S., midteens China), 8%-10% operating income growth (suggesting 17%-18% operating margins), and "at least 10%" EPS growth.

We're not planning material changes to our $74 fair value estimate and continue to view Starbucks as one of the most attractive names in the restaurant industry today with several potential catalysts in the pipeline (new store formats and expanded delivery capabilities). Over the next 10 years, we anticipate average annual revenue growth of 8%, factoring in roughly 2-3 points of revenue growth impact from the GCA partnership beginning in 2020, 6% average annual unit growth, and 4% global comps driven by Mobile Order & Pay and other digital initiatives, new beverage/food innovations, and restaurant throughput enhancements. Over a longer horizon, we anticipate operating margins exceeding 20% driven by sales leverage from streamlined store operations and technology initiatives, international scale improvements, and contribution from the GCA.

Looking closer at the first-quarter results, the 4% comp increase in the U.S. was driven by a 4% increase in average ticket (3 points from beverages--largely cold beverages that are helping to improve afternoon daypart weakness--and 2 points from food, offset by a 1-point decrease due to a designed reduction in-store merchandise) and flat transactions growth (the third straight quarter of sequential improvement). Although early, China is benefiting from higher transactions through its delivery partnership with Alibaba, and we expect transaction trends to steadily improve as heavily promotional competitors are forced to raise prices. Management adjusted the language behind its 2019 comp outlook--now calling for 3%-4% growth as opposed to the low-end of a 3%-5% range--but we see a number of levers in both regions that should keep the company toward the high end of this range, including digital engagement (Starbucks Rewards members jumped 14% to 16.3 million in the U.S.), delivery (including the UberEats partnership that will be rolled out to one quarter of Starbucks' U.S. company-operated stores by the end of the second quarter and increased contribution from the Alibaba partnership in China), and new store layouts (including drive thru formats in the U.S. and "Star Kitchen" locations in Alibaba's Hema/Freshippo stores).

We still see Starbucks' other targets for fiscal 2019 as reasonable, including 2,100 net new stores (1,100 in China/Asia-Pacific, 600 in the Americas, and 400 in EMEA), revenue growth of 5%-7% (including a 2-point hit due to streamline-related activities), a slight increase in adjusted operating income growth (excluding the impact of its CPG partnership with Nestle) despite employee and technology investments, some G&A leverage, adjusted EPS between $2.68-$2.73 (a $0.07 increase from previous guidance because of certain tax items), and $2 billion of capital expenditures. We're also encouraged that Starbucks continues to see strong returns among its new store openings in the U.S. and China, giving us greater confidence that the company is adjusting to the convenience and experience need states at the individual store level, something that we discussed in greater detail in our Dec. 28 piece, "Why Starbucks Is Our Top Restaurant Pick Heading Into 2019."