Starbucks Stock Tanks – Teavana Unit to be Shut Down

Starbucks shares fell 5.6 percent to $56.15 in after-hours trading yesterday after the  company reported disappointing global sales growth Thursday. Starbucks operates 24,464 coffee shop locations world-wide.  The 46-year-old coffee shop operator trimmed its adjusted earnings per share forecast to between $2.05 and $2.06 this week.

At the current share price of $54.53 (at noon, Friday, July 28th), has fallen 8.34% off its previous closing. Runner-up Dunkin’ Donuts, at $52.54 per share, pays an estimated annual dividend of $1.29 per share on just 12,000 stores. That makes Starbucks the better buy, right?  Well, maybe not.

One of the key differences between Starbucks and Dunkin Donuts is that all of the Starbucks locations are company owned stores, while Dunkin Donuts is a franchise operations.  This means that the Starbucks receives all the revenues from its stores, while Dunkin Donuts only receives a percentage of the revenues generated by their franchisees.  It also means that start up costs for a new Dunkin Donuts location cost the company almost nothing, when compared to the average startup costs for a Starbucks location. The average cost for a free-standing Dunkin Donut location is around $200,000 but that is paid by the franchisee, not by the corporation.  The average cost per unit for a Starbucks location is around $400,000, all of which comes from the corporate coffers.

Starbucks is threatening to add another 12,000 locations that would cost approximately $480 million. That expansion could super-saturate the coffee house market, leading to lower per store sales. More importantly, competing against Dunkin Donuts is a sucker bet. Just ask the folks at Krispy Creme about that.

Starbucks draws a younger crowd than Dunkin Donuts but, with an aging population, that might not be such a good thing. Check out any Starbucks. Look at the crowd. Then go to the nearest Dunkin Donuts location: the crowd there will be significantly older. This is in part because older Americans grew up with Dunkin Donuts and are accustomed to the taste of their coffee. DD also specializes in milder brews than Starbucks, which many older consumers find more bitter than the Dunkin Donut brew.

Starbucks reports global sales from its coffee shop business rose four percent at established locations for the quarter ended July 2.  In the U.S., sales rose five  percent at established locations, but indicates that the increases are coming from higher spending at established locations rather than increases in traffic volume.  New store openings contributed drove total revenues up by eight percent to $5.66 billion.

That nets out to a global earnings contribution of four percent to the bottom line, but this was less than third party analysts predicted.  (Established locations indicates that these figures reflect year over year comparisons and do not include new locations that have been open for less than a year.)

The Failed Teavana Acquisition

Starbucks bought out the Teavana chain in 2012 because former Starbucks founder and CEO Howard Schultz believed that the growing number of tea drinkers in the U.S. represented a significant expansion opportunity for the company.

Starbucks is closing down all 379 Teavana locations over the next twelve months according to Starbucks CEO Kevin Johnson’s announcement on Thursday. In that announcement, Johnson noted declining foot traffic at malls was a major reason for the move. “We felt it was an appropriate time to take the decision and begin shutting down those stores,” he said.  Johnson also disclosed that the company plans to rely on customers spending more on pricier drinks and food to grow sales at its namesake coffee bars. Translation: brace for price increases at the pump.

Schulz, the epitome of the hyperactive CEO during the 1980s,  invented the Starbucks business model when he was working for a Seattle based coffee retailer named “Starbucks Coffee Company” in the mid 1980s. He based his concept on the classic Italian coffee bars he saw in Italy.  His bosses at Starbucks agreed to try out a pilot store, then switched gears and focused their attention on the Peet’s Coffee & Tea brand.  Schultz went ahead and launched his own coffee bar, “Il Giornale.”  He purchased the Starbucks retail unit and brand name in 1988.

That bet paid off very well for Schultz, but his Teavana bid turned out to be short-sighted for three reasons.

The first reason is that Teavana locations in U.S. malls are suffering from the falling traffic figures for most of these locations, an affliction shared by other mall-based chain operations, including the Starbucks stores.  The second reason was that Teavana’s pricing strategy resulted in a cup or glass of tea that cost as much or more than Starbucks’ coffee drinks. With the two chains often located within close proximity to each other in many mall locations, the Teavana locations were actually drawing customers away from nearby Starbucks locations…without drawing enough other business to make the Teavana operation viable.

The third and most costly mistake was that Schultz failed to take into account the simple fact that it is much easier to brew a good cup of tea than it is to brew a good cup of coffee, which is why there are so many coffee making machines on the market but virtually no tea making machines. All you need to brew a good cup of tea is a cup and a tea kettle. (Please do not microwave your tea water or use boiling water to brew your tea. The best tea is made with water that has not quite boiled yet.)

If the new Starbucks CEO is planning to increase revenues by jacking up prices, he may be in for a rude awakening of his own.  Competition has intensified in the restaurant industry, making it more difficult  for chains to get customers to visit their stores more often. Same store year over year figures are declining across most fast food and informal dining establishments. Industry maker Dunkin’ Donuts said earlier in the day that its customer traffic fell again at its established U.S. locations.  Even low-end food outlets like McDonald’s are cutting into Starbucks trade by offering low cost beverages that compete with Starbucks and Dunkin’ Donuts offerings, along with a wider array of food offerings.

Starbucks unveils plan to add 12,000 stores

Johnson dismissed the idea that competition from low end outlets is effecting Starbucks bottom line, saying that the “value players” are competing in a different segment.  Nevertheless, the company cited pressure in the retail and restaurant sectors that have made it more cautious going into the next quarters. It cut its profit forecast for the year for the second time. In December of 2016, the company announced plans to open an additional 12,000 units by 2021, opening up the prospect of having a Starbucks next door to every Dunken Donuts, if not one on either side. The company is suggesting that the expansion plan will add 10 percent to their annual earnings by the time the roll-out has been completed while infusing the world with 36,000 Starbucks stores.