Is Starbucks Stock Worth Watching?
In this podcast, Motley Fool analyst Asit Sharma and host Dylan Lewis discuss:
In the face of revenue declines and struggling comps, are Starbucks' shares worth watching?
Amazon's eye-popping operating margin, fueled by strength in its ad business, the cloud, and cost-cutting measures.
The name of the game in food is innovation. Motley Fool host Mary Long talks with food and beverage analyst David Henkes about McDonald's new approach with CosMc's.
To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.
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This video was recorded on May 01 2024.
Dylan Lewis: The triple-shot, two-pump strategy hits a snag. Motley Fool Money starts now. I'm Dylan Lewis, and I'm joined over the airwaves by Motley Fool Analyst Asit Sharma. Asit, thanks for joining me.
Asit Sharma: Dylan, thank you for having me.
Dylan Lewis: It's a big week for earnings. We've got results from two major names that are painting a cloudy picture of the consumer, maybe a conflicting picture of the consumer. Asit, I want to start with Starbucks. Shares down 15% after the company earnings update showed a 2% decline on the top-line and also earnings that missed expectations. What was the culprit here behind the pullback?
Asit Sharma: Dylan, the culprit was declining traffic in North America, which is a core market, and also in the major investment markets that Starbucks has emphasized, like China. You had declining same-store sales, which is never a good sign, and this is something that the market is really trying to digest. It was a surprise that the company missed estimates, and the outlook is gloomy. When you have lower same-store sales that are predicated on less traffic, even if you've got a little bit of pricing power, which Starbucks has, that always makes investors worry. When are you going to pick that traffic back up? I think there are some reasons why the traffic is declined. That's easy to see, especially in North America, but we can get into that as we go.
Dylan Lewis: You mentioned price power there, and I couldn't help as I was looking through the results and seeing some of these year-over-year declines, to think this is a company that has flexed their pricing power and been able to continually move things up. Are we seeing people say, you know what, it's just not worth it for me to pay that little bit much more this many times a month. I'm going to cut back the number of visits that I'm making to Starbucks because the pricing is just getting a little out of hand.
Asit Sharma: I think there could be some of that for sure, and we see that in places like California where, like other restaurant systems which have to serve people on a unit basis very quickly, raising prices because California's implemented some new wage standards is causing this weird dislocation, where investors are having to make that very same decision. The other place we see it is in throughput, and this gets to maybe some of the issues that Starbucks is having that's going to last more than just a few quarters. Management talked about the fact that they really can't serve everyone in their morning daypart. If you drive by a Starbucks in the morning, you've seen the lines of cars that pile up there. This is something that really didn't matter to consumers outside of the pandemic. People want their coffee. There was a lot of still disposable income sloshing around, so it didn't matter. The company could both make customers wait and charged more for the same product. Now the dynamic is different. Starbucks management is acknowledging that consumers are a little more jumpy. They're watching their dollars more carefully, thus if you're in a line, and it's expensive anyway, and you're waiting and waiting, you have a tendency to just pull off that line, so this becomes a problem of throughput. How fast can you get consumers through that drive-through or in and out of the stores? Starbucks has been working on this problem for a while, and they've got some solutions. Some listeners may be familiar with, it's a thing called Clover. This is a small company that Starbucks bought several years ago, and they took those machines and modernized them. They're basically machines that give you a lot of variability in the components, how you make a cup of coffee. It can make a cup of coffee faster than a barista can, and this has been modernized. Now we're seeing Clover in some more Starbucks locations that's supposed to help speed up the whole process of serving a cup of coffee. They have a similar system for the more difficult part of their service, which is serving cold drinks, that's called Siren. The Siren System is supposed to be a solution, but Dylan, there's a bottleneck on the bottleneck. If traffic is a bottleneck, Starbucks is taking a lot of time to test this system. It's been slow to roll this out. We've been hearing about it for a couple of years, so management talks about this as an opportunity. Hey, if we sped up the lines, we actually could record more sales, but so far, management hasn't been able to operationalize on these enhancements, and that's also causing investors to worry.
Dylan Lewis: You mentioned the dayparts there. That came up in management commentary as one of the main things that they see as an execution opportunity to address. It was interesting. They dove a little bit into this idea that they are seeing all of these people in Mobile Order and Pay, in particular, go begin to order something and then abandon, and my takeaway there, Asit, is you can make something expensive as long as it's convenient, but if it's expensive and inconvenient, you are going to see consumers vote with their dollars a little bit more. Some of the other execution opportunities that management identified was continuing to launch new and exciting products. I think that is a little bit tougher for investors to say, OK, we are definitely going to see signs of success there, there have been some really breakthrough products for them, but they tend to be very seasonal and a little bit harder to predict. The third thing that they threw out was reaching and demonstrating more value for occasional and non-Starbucks rewards consumers. What I think I'm reading there, if this is correct, is they are seeing strength with their loyal consumers, but a lot of their more occasional buyers are those more price-sensitive folks that maybe are turning away and not going quite as often now.
Asit Sharma: It could be. I seem to think similarly. Here Starbucks has some opportunities. They really have done a great job with incentivizing their loyal customers to come in, but at the same time, they've degraded the value of the Starbucks points over the years. We've seen that with airlines as well. I'm not so sure that it's the best solution to reach the occasional customers much. I feel like maybe some reinvestment in the value of the Starbucks loyalty program would help them first. You always have an easier lift incentivizing the core customer versus coming in and trying to entice a customer who hasn't visited as much, but I see and acknowledge the need to to try to get as broad a swath of customers coming in as possible because, if there is this traffic problem, so why not try to fill those gaps in different dayparts with folks who don't come in to smudge?
Dylan Lewis: One of the other ways the company is looking at their dayparts and their operations is testing some after-hours concepts and delivery. They piloted serving customers between 5:00 PM and 5:00 AM and said that, based on the success they were seeing there, they see that this could potentially be a $2 billion business over the next five years. They're going to continue to expand, so we are seeing experimentation. We're seeing innovation in different ideas here with Starbucks. It just feels like one of those quarters where we saw some hints of this last time. We're really seeing the brunt of it this time. Asit, I look at the five-year chart for Starbucks, and we have seen them down around where they are now twice in the last five years, both of those times have been very short-lived. One of them was March 2020 with the COVID reaction. The other was in 2022 with the very broad market sell-off. Shares did not stay around where they are right now for very long. This company certainly has challenges, but it seems like it also has opportunities. Do you feel like Starbucks is worth looking at right now?
Asit Sharma: I think Starbucks is always worth looking at, Dylan. The question is though, what's going to happen in the next couple of years with the macro economy? We're learning that even Starbucks customers have their point of price sensitivity. In 2020, as you rightfully point out, that was a short-lived drop, but the Fed was also sloshing money around, so the effect was easy enough to bounce back from. What I'm worried about here is, if the customer remains crimped for the next couple of years, what will Starbucks rely on to get that revenue growth jump-started? It's not going to be in building more stores. It could be in converting more stores to the self-serve model, where they take out the seats and use simply order and take your drink away, more of the conversions to drive-throughs. Those could be really solid growth propellants, but short of that, investors are wondering, how are you going to come back from what looks like a little bit of deceleration here? That's always harder to do. Starbucks has the tools, it's got the brand power, but it may not be a quick bounce-back. This could be a place to buy Starbucks, but I'm not so sure we'll see that six-month resumption of a very strong chart here. There's something a little amiss underneath all of this that I think management is still working through itself, and it may take a couple more quarters to unravel exactly what's going on, but from the top, i think your census is correct that part of it is this consumers is pulling back.
Dylan Lewis: We had a more certain picture with Amazon's results and maybe more of a business-as-usual type story. Revenue up 13% in the company's report to 127 billion. The number that jumped out to me though is operating income up over 200% year-over-year to over 15 billion. I did the math on operating margin here and did a look-back quarter-to-quarter. Asit, I don't think the company has ever touched 10% for an operating margin. Is this a new normal for Amazon?
Asit Sharma: It could be, Dylan. One thing that Amazon has now, which it didn't have before, is sustained profitability in its e-commerce operations, and it got there by doing something. it's used as an explainer for why Amazon Web Services hasn't been as profitable lately, cost optimization. So when you look at Amazon Web Services in quarters before this quarter, management was saying, look, all our customers want to watch their spend because of this uncertain economy, so our profits are a little smaller. They were doing the same thing over in the business of logistics in distribution for the e-commerce side. I think that's a more solid business day. All the work Andy Jassy has done in terms of looking at each business division within Amazon as a holistic enterprise and then paring away what doesn't work is starting to show up in these numbers. So they could be there, and Amazon Web Services itself is doing well. Digital advertising is a nice contributor to that profit margins. You put it all together, I think we could be here, and as you point out, that's not a huge margin, but at a scale when the sales are in the hundreds of billions, it starts to make a difference.
Dylan Lewis: Let's talk about that advertising segment for a second. It was up 24% this quarter. That is better growth than its AWS segment. I'll say it is at about half the size of the AWS segment as it currently is, but this was the first time that we had a look at their advertising segment with the benefit of Prime Video being included. I think we have just continued to see the success in what Amazon is able to do. I have to think that this segment is going to become a bigger contributor for the company going forward.
Asit Sharma: It should. It's such a high-margin segment for them, and it shows too you don't have to be necessarily the best in terms of content quality. We do know that Amazon has a lot of scale now, so it is a pretty worthy competitor to other streaming businesses, but technology matters. Their technology is pretty good. We see this with Netflix as well, the ability to show advertisers very good conversion on display. They've got that. I think the way that Amazon has approached this isn't the most exciting business, but it's been a steady builder. Again here's this theme coming in Del, now it's reaching scale so it starts to impact that bottom line.
Dylan Lewis: Shares were up about 3% on the report, and I feel like people were saying, these are strong results. They're not blowing the, the cover off the ball, but looking pretty good, if there were any things to take exception to and nitpick on, maybe it was the guidance we saw that they were coming in a little bit below expectations for some of the out quarters this year. I do wonder if they are signaling a little bit of that concern that you're mentioning earlier around consumer tightness and just wondering if the macro picture may affect spend a bit.
Asit Sharma: I think it's smart of them to do that. It's a business which again, has so many different contributing parts and pieces, but there's not a dominant piece of this business, so if the macro economy gets soft again, each of the big segments, think about AWS, think about those online sales, they'll have some marginal reduction, so it is smartest management to do that. I'll pick a quibble here too with the results. So one thing that I'd been counting on for a long time is, after Amazon built out its distribution network, its logistics fulfillment network, we were supposed to enjoy a lot of amazing free cash flow, and we're seeing it. It's there. It's grants. Now looking forward, some of that free money is going to get eaten up because Amazon is investing in generative AI. That's a benefit to the business, but all the free cash flow, some of the grander numbers that I saw analysts project, I don't think they're going to materialize now. I think Amazon is going to keep investing its spare cash in providing a multilayer of services for AI. That's to the benefit of Amazon long-term, and management talked about this on the call. They go through cycles of investment and then expanding margin and then lower-margins investments.
It never ends. I guess there's always something that eats up the available supply of capital that we keep thinking Amazon one day is going to throw off nonetheless. It's really hard to argue with this report in general.
Dylan Lewis: Asit, no quibbles with your analysis or ever having you on the show. Thanks for joining me today. My colleague Mary Long caught up with David Henkes, a food and beverage analyst at Technomic to learn about McDonald's CosMc's content.
Mary Long: David, you are one of my go-to's when I want to understand what's happening in the food and beverage industry, and I really wanted to talk with you because McDonald's, at the end of last year, launched a pretty interesting new venture. It's called CosMc's. It's a space-themed beverage outpost. It also sells some snacks there, the first launched outside of Chicago. There's a couple of now in Texas. The plan, if I remember correctly, by the end of the year, is to have 10. I've got some business and strategy questions for you that center around what this means for McDonald's, what this means for the beverage space more largely, but I think you're one of the lucky few that have actually been to a CosMc's, so maybe we can start by having you tell us what that experience was like.
David Henkes: Thanks for having me on. I did go to the CosMc's. I live just outside of Chicago, and the one here is in Bolingbrook, which is a western suburb of Chicago. I went there. It's a drive-through only concept. It's got golden arches hidden among all of its CosMc's brand name, so it's certainly not trying to hide the fact that it's a McDonald's concept. Interestingly enough, the one in Bolingbrook is right next to a McDonald's, and so as I waited in line for about 40 minutes to get through the drive-through, I watched the McDonald's drive-through which was essentially empty. So they've clearly had a lot of success in terms of driving interests, traffic, sales to the one here in Bolingbrook and to your point, they've I believe they've got two maybe three now in Texas with and my understanding is the same as yours is they want to have 10, so it's something that I think the entire restaurant industry is keeping an eye on and is fascinated by, and we'll see where it goes.
Mary Long: The menu is pretty funky. I'm going to just list off a few offerings that listeners, that maybe are unfamiliar, have an idea of what's actually being offered. There's a Sour Cherry Energy Burst, which is like a slushy that comes with caffeine syrup, sour cherry flavoring, as you might expect from the name, and boba balls. There's a Beach Protein Frappe, so a milkshake-like offering with banana flambe flavoring and protein powder. A churro cold brew frappe, that's probably more self-explanatory but interesting flavor combinations there. There's an assortment of coffees, hot and cold, sour and tea-like beverages. Some more familiar items you mentioned the golden arches are hidden within this whole concept, plus some new sandwiches and bakery items. When I hear all that, who is this menu trying to cater to? Is there a specific demographic that McDonald's might be trying to attract here?
David Henkes: I think when you look at a lot of this beverage innovation that they've got on the CosMc's menu, it's clearly aimed toward the younger demographic, Gen Z. Primarily when you talk about these energy drinks, cold coffees, the refresher style drinks that Starbucks has been introducing and has had wild success with, all of these are really aimed toward, certainly not my generation, but they tend to be sugary drinks but high energy and a lot of innovation flavors. To your point about boba, boba has been on a tear lately. So the menu, I think, is built around what McDonald's considers some of the emerging opportunities in beverage, and beverage frankly right now is a hot area ripe for innovation. We see a lot of these stand-alone beverage concepts, Dutch Bro's HTO. There's a number of these beverage forward drive-through concepts that have emerged over the past year or two years. It seems that they've really popped on the scene. McDonald's, within its current four walls of existing McDonald's finds it very difficult to innovate and test out some of these new products. It gets in the way of the flow of the operation. and it's challenged. One of the things that I think CosMc's does for it is it really provides an incubator for them. But it also then doesn't allow them to necessarily alienate the consumers that are coming into McDonald's, and so it gives a separate outlet for them to test some of these things with perhaps this demographic, and McDonald's caters to everybody, and so they, I think, are not trying to be super cutting-edge within their McDonald's menu. What they're trying to do is figure out maybe some opportunities for growth that could be incorporated into McDonald's, and I believe, and I think it's true, that they're using CosMc's as that incubator, as a test site, to try out a lot of these with Gen Z and with the younger consumers especially, but just to see how they resonate and to use it as a test site.
Mary Long: I think when news of this launch first came out, a lot of people made the observation that this was McDonald's trying to compete with Starbucks and maybe Duncan and other players in that beverage only type lane or beverage forward type lane. It sounds like you, rather than direct competition, you see this as more like an experimentation space. If that's the case, what do you think the longer-term play is here? Is it to build beyond those proposed 10 CosMc's locations and make this a really substantial stand-alone brand or more so to maybe bring one winner from a CosMc's hub, a CosMc's experimentation place into a full-time McDonald's.
David Henkes: McDonald's won't come out to say it, but I think if you read between the lines, listen, whether they have 10 or 100 or even 1,000 CosMc's, McDonald's has roughly a little over 13,000 McDonald's locations in the U.S. They've got about 42,000 globally, so this thing could be a wild success, and it's still going to be a rounding error for McDonald's. McDonald's generates something around $130 billion globally in terms of sales. We see it actually just today. Chipotle just announced today that they're discontinuing their, I think is, Farmesa concept. It's a bowl concept that they were trying. The restaurant industry has a lot of examples where secondary brands do not get the attention, the focus, the investments when you've got a big brand that's growing pretty well, and so there's no question that if this were intended to be a stand-alone brand that they wanted to grow, the success of similar brands in the industry would suggest that it's probably not going to work, including, by the way, McDonald's which used to own Chipotle and spun it off because it was a distraction. The only way, in my opinion, that this really makes sense for McDonald's to grow this and to invest in it, is to use it as an area to test things, to fail quickly, to incubate new ideas, to be unencumbered by how McDonald's currently does things and do things completely different. I think what it means is that beverage as the platform for competition in the future has been acknowledged by a lot of QSR fast food chains. This is McDonald's way of testing and getting more into beverage and figuring out things that work and items that their customers like without completely impacting their McDonald's operations, which by the way is humming along. They grew 9% last year, so the McDonald's business by itself is doing just fine and they don't want to touch that, impact that, slow down drive-through lanes, or impact operational effectiveness, so CosMc's really gives them the chance to have a new sandbox, new playground to try things out in and do it unencumbered by the equipment or the training that their existing McDonald's staff has. They can be as, as out there as they want. The real value then is how you monetize some of these learnings into the $130 billion globally that McDonald's sells because, if you can grow that 5% based on some new beverage learnings, that's a whole lot more impactful than having 50 or 60 CosMc's restaurants which, while they might be successful, are not going to have a material impact on the McDonald's business.
Mary Long: CosMc's is a full-on drive through, and it's completely cashless. You order and pay at a drive-through kiosk. Is this the future of fast food, people lists cashless, automated order takers and kiosks?
David Henkes: Yeah. Listen, there's a lot of automation that's happening, primarily in fast food, quick service, fast casual right now. You see some but lessened full service, and a lot of it's driven by the labor situation, so you've got this law in California now, minimum wages are going through the roof. That's having a knock-on effect throughout the country, and so a tight labor market compounded with higher minimum wages makes it tougher and tougher for restaurants, A, to be profitable and, B, to find the people that are going to drive restaurant sales. Automation is certainly an output of that, but listen, labor, we went back to some work we did in 1970. You know what the number one issue facing the restaurant industry in 1970 was? It was labor. Labor is not a new issue for the restaurant industry. What is new is the technology and the ability to drive some incremental sales with it, but realistically, this automation doesn't really replace labor for the most part. It really redeploys labor, and so you're never going to totally take the people aspect out of it. What labor does is it enables more frictionless transactions. Hopefully it drives speed of service, and especially in a convenient environment like QSR is, unlike where there's drive-throughs or a high throughput necessary, the more you can eliminate obstacles and barriers and create that frictionless environment,the better guest satisfaction you have, and hopefully you can redeploy your labor into some higher value added activity. I think that's what a lot of the technology is doing nowadays. They're not necessarily taking labor out, but they're trying to redeploy it and use technology to drive guest satisfaction and, hopefully, drive some incremental sales.
Dylan Lewis: As always, people on the program may own stocks mentioned, and the Motley Fool may have formal recommendations for or against, so don't buy or sell anything based solely on what you hear. I'm Dylan Lewis. Thanks for listening. We'll see you tomorrow.
John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Asit Sharma has positions in Amazon and McDonald's. Dylan Lewis has no position in any of the stocks mentioned. Mary Long has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Amazon, Chipotle Mexican Grill, Netflix, and Starbucks. The Motley Fool has a disclosure policy.
Is Starbucks Stock Worth Watching? was originally published by The Motley Fool
