Starbucks shares plunged by as much as 15% after reporting its results on April 30th.

The results were so disappointing that it prompted the ghost of Starbucks to write a long post on LinkedIn. I’m only half kidding when I say this because I wouldn’t be surprised if Howard Schultz returns for a third time as CEO.

Here are some key excerpts from Schultz LinkedIn post:

“Starbucks announced earnings last week, and unfortunately, significantly missed shareholder expectations… U.S. operations are the primary reason for the company’s fall from grace. The stores require a maniacal focus on the customer experience, through the eyes of a merchant… Senior leaders—including board members—need to spend more time with those who wear the green apron. One of their first actions should be to reinvent the mobile ordering and payment platform—which Starbucks pioneered—to once again make it the uplifting experience it was designed to be. The go-to-market strategy needs to be overhauled and elevated with coffee-forward innovation that inspires partners and creates differentiation in the marketplace, reinforcing the company’s premium position. Through it all, focus on being experiential, not transactional.”

The company is under siege on both fronts—its core U.S. market and the China market. Let’s unpack that.

North America: Woes at home

Revenue in the North America segment remained flat at US$6.4 billion, and a deeper look reveals troubling signs.

North America comparable store sales declined by 3%, driven by a 7% decline in transactions, partially offset by a 4% increase in the average ticket. In other words, they raised prices but consumers have decided to make coffee at home instead.

Perhaps the most concerning news was the sequential decline in Starbucks Rewards loyalty program 90-day active members, from 34.3 million in Q1 2024 to 32.8 million in Q2 2024, a 4.4% decline. Apart from the COVID lockdowns in 2020, this is the first time active members have declined in the past decade.

In my first deep-dive into Starbucks published in 2021, I explained why the membership program was crucial for the green mermaid’s growth:

A decline in active members is a slippery slope, leading to a drop in transactions and eventually affecting the float, which is the cash balance in its customers' Starbucks cards—a whopping US$1.9 billion in interest-free loans as of March 31st.

North America operating income fell 5.7% to US$1.15 billion, with operating margins declining 109 basis points to 18%.

The F&B business has high fixed costs, so a decline in sales typically results in an even faster decline in profitability. If Starbucks doesn't address its domestic issues, we could see earnings evaporate at an accelerated pace.

What perplexes and frustrates me is how a major player like Starbucks allowed its app user experience (UX) to become a key bottleneck for their business when it drives over 60% of their morning orders. Laxman Narasimhan, current CEO of Starbucks, explains, “more than 60% of our morning business in the U.S. comes from Starbucks Rewards members who overwhelmingly order with a Starbucks app… Despite strong Mobile Order & Pay sales, we saw a mid-teens percent order in completion rate within the order channel this past quarter. In other words, customers put items into their cart and sometimes choose not to complete their order, citing long wait times of product and availability.”

International: Things aren’t pretty abroad as well

Revenue in the international segment declined 5% to US$1.8 billion, despite a 9% increase in the store count to 20,886 stores...

Share Buybacks Won’t Fix a Damaged Moat

Since 2018, the company has spent a whopping US$26 billion buying back shares, reducing the diluted shares outstanding by 18.6% to 1.1 billion shares.

This was done in part by using their cash flow and taking on debt. Total debt more than tripled from US$4.7 billion in 2017 to US$15.6 billion today. While this didn’t cause the company to face liquidity problems during the COVID-19 lockdown, it raises questions about missed opportunities.

With the debt burden, Starbucks may have lost the chance to emerge from the crisis even stronger by investing heavily in the business to capture more market share, securing prime locations as many F&B outlets were shutting down, doubling down on digitization efforts, or accelerating share buybacks when the share prices were depressed.

Instead, share buybacks slowed significantly during COVID-19 when the share price fell to as low as $58.

Capital spent on shares buyback:

2018: US$7.2 billion

2019: US$10.3 billion

2020: US$1.8 billion

2021: US$0.1 billion

2022: US$4.1 billion

2023: US$1.1 billion

2024 H1: US$1.4 billion

Where does the US$26 billion worth of share buybacks leave us? The company was trading at $60 per share at the start of 2018, and today it’s trading at $79 (as of 24 May 2024), yielding a CAGR of 4.3%, significantly lower than the S&P 500 returns of 9.9% over the same period.

Starbucks broke the cardinal rule when it comes to share buybacks. According to Warren Buffett, buybacks make sense only when:

1) The company has enough funds to maintain its competitive position,

2) There’s nowhere else to reinvest at attractive returns, and

3) The company’s stock is selling below intrinsic value.

The company has clearly broken rule number one, as it finds its economic moat damaged and under attack by competition.

Next, let us see how the company plans to repair its moat.

Starbucks attempt to fix its economic moat

Starbucks’ strategy to rectify its issues includes expanding its food and beverage offerings, opening 3,000 new stores globally, opening the Starbucks app to non-Starbucks Rewards members, and spending US$600 million over the next three years to digitize stores with digital menu boards and AI to better understand consumer behaviors.

Management also mentioned addressing inefficiencies, reducing product and distribution costs, and investing in creating a better working environment for its staff.

However, these solutions don't seem to fix the root of the problems...

Join Steady Compounding Insider Stocks to access the full report and discover why I believe the current management strategies are insufficient to address the firm’s issues.

See you inside,

Thomas
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