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Starbucks is still ‘sensitive to consumer demands’ amid food price inflation: Analyst

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Morningstar Analyst Sean Dunlop breaks down Starbucks' third-quarter earnings beat, the chain's global sales growth, and how the brand is faring against inflationary factors and China's COVID shutdowns.

Video Transcript

- Taking a look at Starbucks shares, reporting their earnings today. As we can see, the stock up about 2% in after-hours trading. Let's take a deeper dive into this. We'll break down the results. With us now is Morningstar analyst Shawn Dunlop. So as we saw there, despite the headwinds, Starbucks still pulling ahead here. What are your big takeaways from this?

SEAN DUNLOP: Yeah. I think going into the quarter, there are three things I was really looking for. The first is was we going to see any sort of softening in consumer demand? Were people going to trade down the menu or out of the category entirely as they saw their real incomes declining? Two, what did profitability look like? Were we starting to make our way through this triumvirate of cost headwinds that we've seen? And then three, is there anything structurally impaired about the business moving forward? And sort of as we check through those boxes, there's a lot to be encouraged about.

So top line momentum was pretty strong. In the United States, I had 10% comparable store sales. We ended up getting 9%. But it was encouraging to see that split between price and traffic, meaning that you don't see consumers entirely trading out of that category. In terms of profitability, you had restaurant margins in the United States were about 19%, 19 and 1/2%. They were as strong as we've seen them since the fourth quarter, fiscal fourth quarter a year ago.

And that's certainly encouraging. And in terms of the long-term health of the business, growing those China units a little bit north of 12% is a really big vote of confidence in that market and something that we like to see, particularly with the pressure that we saw in terms of comps and in terms of profitability in the international segment. So all things considered, pretty good.

- And Sean, just to jump in there, in a note to Yahoo finance you said that Starbucks is a lot more sensitive to those margin headwinds, with nearly 80% to 85% of sales tied to company-owned stores. Of course, Starbucks CFO saying that consumer demand is not slowing down in the release. But should an economic downturn happen, how do you think that Starbucks would fare here?

SEAN DUNLOP: Yeah. It's a good question. It is an affordable luxury product. But it is not a luxury product. So Starbucks is sensitive to consumer demand. It is a cyclical product. And as you point out, when 80% to 85% of sales tied to those company-owned stores, Starbucks finds themselves a lot more sensitive to pressures below the line, the inflation that we've seen in food costs, the inflation that we've seen in restaurant labor, and the inflation that we've seen and continue to see in fuel and utilities.

So when you consider Starbucks results versus an operator that's heavily franchised like Yum! brands or Restaurant Brands International or McDonald's, they're going to be quite a bit more volatile. And as consumers trade down a little bit down the menu and they look for value, typically in terms of what you get for the money, a lot of those QSR operators like McDonald's or Domino's tend to outperform on a relative basis at least.

- And to dive into a bit of those global sales number, that was largely decreased, and that decrease driven by China there. Decreased 44% in just China alone. What exactly sort of demand are you seeing there, despite that zero-COVID policy? Are you expecting that to turn around in the years to come, despite COVID hopefully not taking another toll?

SEAN DUNLOP: Yeah. It's a good question. I think the encouraging thing with that China business is all of that was driven by traffic, which feels a little bit more ephemeral. Traffic, obviously, is going to be severely impeded. It's a dine in heavy market in China. And then with the mobility restrictions that we've seen, it was not entirely unforeseen. So for a sense of perspective, we expected comparable store sales in the segment to be down about 35%. So it was worse than we realized. But also, COVID-induced restrictions were worse than we realized.

So as we move forward in that market, I think the big thing to look for will be-- vaccination rates in China continue to increase. Appetite for that zero-COVID policy continues to decrease. So over time, we expect that those restrictions will start to loosen. It's more a matter of when consumers can access the stores than it is whether or not the demand is there, which is encouraging. And as we pointed out earlier, the willingness to continue to invest in the market, even as they're generating poor restaurant economics right now, suggests that they expect that to turn around, either in the second half of this calendar year or certainly at the latest the first half of next year.

- Sean, when we talk a lot about these chains, a lot of the focus has been on some of their loyalty programs in order to get those repeat customers especially through their doors active. Starbucks rewards membership of 13% in the US to 27.4 million members. I know there was a lot of emphasis on this program when it was initially launched. What's your reaction to that growth? Does there need to be more of a focus on that here in order to really build a business going forward in the US?

SEAN DUNLOP: Yeah. There's so much to like about the loyalty program. So it saves costs in the restaurant as you think about automating some of those orders and scheduling some of those orders and sequencing some of those orders instead of having to do that at the register. More than half of orders are now coming through the loyalty program and have for some time in the US. That comparable figure is as high as 75% in China. So there's certainly room to grow there.

But there are plenty of benefits to loyalty. I mean, you can use targeted promotions to drive guest frequency. You can push guests towards days where maybe you get a little bit less traffic. You can maybe get them to visit in the afternoon day part. So more than half of Starbucks sales come before 10:00 AM. If you can get somebody to visit at 2:00 PM, it's very incremental.

And then the third point is with those loyalty programs, you can target your marketing. So if you've got a customer that's a little bit more price elastic, maybe you can offer them some sort of coupon without having to necessarily do a national offer and discount customers that would otherwise be willing to pay full price.

- Sean Dunlop of Morningstar, thanks so much for joining us. And of course, our thanks to Brooke Depalma as well. All right. Tune into Yahoo Finance tomorrow morning for more on Starbucks's--