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Morningstar | Starbucks' U.S. and China Strategic Actions Will Take Time, but Investors Are Paid to Wait

Starbucks spent most of its third-quarter update following up on corrective measures announced in the United States and China in late June. We believe management has the right priorities to stimulate transaction growth--improved customer experience, beverage innovation, and digital engagement--but we still harbor questions about when investors should expect these benefits.

We believe the Starbucks brand remains strong in the U.S.; it's seeing growth among its most loyal customers, across all categories save for Frappuccinos, and during the morning daypart, each of which supports the brand intangible asset behind our wide moat rating. But we expect efforts to re-engage occasional customers will take several quarters, suggesting 3% U.S. comps over the near term. Still, we believe focusing on in-store efficiency, store portfolio management (including where drive-thru locations can augment existing locations to better balance the needs of third-place and to-go/mobile customers), new cold beverage innovations, and more personalized promotions to drive loyalty program enrollment and afternoon daypart transactions are appropriate strategies.

Luckin Coffee and other delivery-first, value-priced competitors have clearly been disruptive to Starbucks China, resulting in a 2% comp decline in the quarter, but we still believe there is a compelling long-term story in the region. Starbucks has been behind the delivery curve, but we believe the nationwide rollout of delivery in 2019 (after the Shanghai/Beijing pilot in the fall) will help to bring comps back to the low to mid-single digits medium term.

We're not planning changes to our $64 fair value estimate, as updated full-year guidance (comps just below 3%, adjusted earnings per share of $2.40-$2.42) appears reasonable. While some volatility is likely as Starbucks rolls out its U.S. and China strategic efforts, investors are effectively being paid to wait with the 2018-20 achievable cash return target of $25 billion.

While management did not provide an initial outlook for fiscal 2019, we're preliminarily forecasting high-single-digit revenue growth based on 2%-3% global comps and 8% unit growth, which we expect to be weighed toward licensed locations and incorporates management's plans to underpenetrated markets in the Midwest and South. We factor in roughly flat operating margins in 2019 and expect any leverage from the modest comp improvement and management's plans to reduce selling, general, and administrative expense by as much as 1 point as a percentage of system sales will effectively be offset by technology and other innovation investments across the system. Based on these assumptions, we believe investors should expect mid- to high-single-digit EPS growth in fiscal 2019, though share repurchases offer a source of potential upside.

Over the next 10 years, we anticipate average annual revenue growth of 8%-9%, factoring in roughly 2-3 points of revenue growth impact from the Nestle partnership in 2019, 6% average annual unit growth (including 150 U.S. store closings in fiscal 2019), and 3%-4% global comps driven by Mobile Order & Pay and other digital initiatives, new beverage/food innovations, daypart expansion, and streamlined restaurant operations. We project operating income growth around 10% over the same time frame, implying low 20s operating margins longer term.