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Starbucks’ Successful Earnings Hint at a Headwind

James Brumley

In early January, consumer-tech giant Apple (NASDAQ:AAPL) sounded the alarm bell: Due to unexpected headwinds in China, Apple dialed back its revenue outlook for the quarter ending December. Other U.S. companies that do business in China were put on notice. Starbucks (NASDAQ:SBUX) was one of those companies.

China’s fast-growing consumer market has been the focal point of the SBUX’s expansion efforts for years. And until last year, the company’s growth there had been outstanding. Apple’s red flag left most owners of Starbucks stock wondering if that growth streak had come to a complete halt.

But it didn’t. Growth remains agonizingly slow, but Starbucks continues to make some measure of forward progress in the increasingly important market.

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There’s still a major concern SBUX stock holders should note about Starbucks’ primary growth vehicle. And it’s got nothing to do with trade tensions or an economic slowdown in China.

Earnings Hint at a Headwind

Thursday morning’s quarterly report shed a great deal of light on what had been an uncertain matter.

For its fiscal first quarter ending in December, Starbucks turned $6.6 billion worth of revenue into a per-share profit of 75 cents.

Both were better than expected, and both were well up on a year-over-year basis. The pros were only modeling income of 65 cents per share of Starbucks stock and a top line of $6.49 billion, and the company only posted a profit of 65 cents per share on sales of $6.1 billion for the same quarter a year earlier.

Starbucks’ bright spot? Everywhere except China.

Globally, same-store sales improved by 4%, while the average orders size was up 3% year-over-year. Those same figures apply to its broad China/Asia Pacific division, but in spite of China, where comparable store sales were only up 1% and the total number of transactions fell 2%.

The knee-jerk explanation is China’s demonstrable economic slowdown, which has tapped the brakes on the country’s consumerism.

The data may also underscore another challenge, however — consumers outside of the major metropolitan areas where Starbucks stores are readily found don’t earn as much as the China’s urbanites do, and as such may not be regulars at some of the company’s newer locales.

Or, maybe China’s coffee drinkers are simply getting their caffeine fix somewhere else.

Enter Luckin Coffee

It’s not a name anyone will see on a sign in the United States, but in China it’s become relatively difficult not to notice the more than 2000 Luckin Coffee locations peppered all across the country. Starbucks is still bigger, with almost 3700 stores in China. But, Luckin says it plans to roughly double its store count before the end of the year, surpassing Starbucks in the process.

It’s audacious, but not unachievable, for an unprofitable startup that isn’t yet concerned about turning a profit.

Worse (for Starbucks stock holders), of all the Luckin’s already up and running, about 1100 of them are within a quarter of a mile of a Starbucks, offering a less-costly alternative. It would be naive to believe the presence of Luckin hasn’t taken some sort of toll on Starbucks’ business in China, and will certainly continue taking a toll as it expands.

Adding to that pressure is that Luckin has found ways to set up shops in key places where Starbacks couldn’t, include the Palace Museum and on several university campuses.

They’re not carbon copies of another, to be fair. Starbucks is largely about the ambience, and Luckin Coffee stores have none. They’re built from the ground up to be run by a lean crew that doesn’t accept cash. Rather, it’s a grab-n-go setup, or better still, Luckin will deliver the order.

Starbucks is also offering deliveries, in partnership with Alibaba (NYSE:BABA) property Ele.me. The benefit of that service isn’t decidedly making a positive impact on business though.

Looking Ahead for Starbucks Stock

So far, the rise of Luckin has been mostly dismissed by analysts. KeyBanc Capital Markets analyst Eric Gonzalez recently noted there’s “room for both competitors to thrive long-term. China per-capita coffee consumption is less than one cup/year compared to 300 cups in the U.S.” Starbucks itself, meanwhile, has commented very little on its new competitor, and doesn’t seem to be terribly worried.

That doesn’t mean current or prospective owners of Starbucks stock shouldn’t worry though. Several Western-minded companies thought they had a firm grip on China’s consumers after some initial success in the market. But, too many of them learned too late they weren’t quite ready to service China’s highly disparate consumers. A few of these outfits found out the hard way they were effectively training their competitors to beat them at their own game.

As of this writing, James Brumley did not hold a position in any of the aforementioned securities. You can follow him on Twitter, at @jbrumley.

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