On April 30, coffee giant Starbucks (NASDAQ: SBUX) reported financial results for its fiscal second quarter of 2024, and the stock was immediately crushed as a result. In a subsequent interview with CNBC, CEO Laxman Narasimhan identified the company’s problem from his perspective by saying: “We have not been able to communicate to [occasional customers] the value that we provide.”
One week later, Starbucks started rolling out the deals for the 33 million users of its mobile app. The company hopes to win business from occasional customers by providing bargains.
I believe it’s the wrong (and a potentially costly) move for Starbucks. And it’s what I’m most concerned about as a shareholder right now.
Why it could be the wrong move
In Q2, the North America division of Starbucks saw a 3% drop in same-store sales. This was comprised of a 4% increase in average ticket and a 7% drop in transactions. Translation: Prices are up but sales are down because people aren’t buying from Starbucks as frequently.
The solution from Starbucks’ management: Let’s lower prices and compel them to buy from us.
In North America, Starbucks had a Q2 operating profit of $1.1 billion, which is good — but it was down 6% year over year. And it was down despite the higher prices it charged. Herein lies a danger for the company: Lower prices could stimulate sales at its locations, yes. But unless it gets a big boost from running promotions, its profits could continue to drop.
The risk to its already struggling profits is one reason that Starbucks could be on the wrong path. But commentary from former longtime CEO Howard Schultz highlights another reason. Schultz said: “U.S. operations are the primary reason for the company’s fall from grace.”
Evidently, former CEO Schultz is diagnosing Starbucks’ problem differently than current CEO Narasimhan. But Schultz might have more concrete data on his side of the argument. In the Q2 earnings call, management said that its order completion rate took a hit because app users are frustrated with wait times and product availability.
To be clear, Starbucks’ app users are among its most loyal customers — these aren’t the folks that you want to be losing. But circling back to management’s plan, it’s trying to drive traffic from occasional customers with bargains, not loyal customers.
This could actually worsen Starbucks’ existing problems, because more people taking advantage of limited-time promotions could lead to even longer wait times. It risks further frustrating loyal customers, and it would do so while lowering profit margins from lower prices.
What it means for investors
The more I allow this plan to percolate in my mind, the more I think Starbucks is making the wrong move here. On one hand, the stock is trading at a once-in-a-decade valuation, which is enticing for value investors. But on the other hand, it doesn’t matter that the stock is cheap if management can’t accurately assess and fix the problems.
It’s as Schultz also said: “It’s not the miss that matters. It’s what comes next.”
Long wait times and lack of product availability speak to an operational problem. If Starbucks addressed these issues with intention and energy, then they could probably be resolved in under a year. But since it’s focused on driving traffic through limited-time bargains, it may take some time to realize it’s on the wrong path, course-correct, and get to fixing the real issues. Starbucks’ operational recovery could consequently still be a ways off.
Fortunately, Starbucks is a strong brand and can withstand periods of waning consumer enthusiasm — at least it has in the past. Therefore, I believe the business will be fine over the long term. But I wouldn’t expect the stock to perk up until operations are showing signs of improvement. Since this may take time yet (because management’s focus appears to be elsewhere), shareholders will need to have an extra dose of patience if they continue holding.
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Jon Quast has positions in Starbucks. The Motley Fool has positions in and recommends Starbucks. The Motley Fool has a disclosure policy.
As a Longtime Starbucks Shareholder, Here’s What I’m Most Worried About Right Now was originally published by The Motley Fool
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