Starbucks' (SBUX) success in China could be key to regaining market confidence in its growth profile on earnings. Unfortunately for investors, analysts and experts are bracing for another slip this quarter.
China has been cited by Starbucks as the fastest growing part of their business for years and has helped prop up falling U.S. sales figures for a good deal of time. The nation is now Starbucks' second-largest market and one of its more profitable.
"Our first strategic priority is to accelerate growth in our targeted long-term growth markets - China and the U.S." CEO Kevin Schultz said in the company's last earnings call. "While acknowledging a disappointing Q3, I want to be clear that we have 100% confidence in our growth strategy and the sustainability of the leadership position we have built in the market."
Given the disappointing results last quarter and the stated importance of the region, Starbucks will need to show it can improve in the traditionally revenue-reliable region, particularly by proving same store sales can rebound.
"China same store sales growth has slowed as the company accelerates unit development," RBC Capital Markets analyst David Palmer said. "A further slowdown could mean the growth potential is not as great as originally expected."
However, putting off a slowdown will encounter resistance from competition and a trade war, possibly causing an even further decline in Chinese sales and hindering overall growth.
China's traditionally tea-driven culture meant that when Starbucks made its incursion into China in 1999, it was able to grow its Chinese business largely unchallenged. It was essentially the only show in town.
Not so much the case any longer.
"We maintain our China Asia Pacific same store sales estimate of -1%, relative to Consensus Metrics of 0.2%," Cowen analyst Andrew Charles said. "Our below consensus positioning reflects caution around China, including commentary on the 3Q earnings call around residual headwinds from competitive promotions that we believe suggests July trends remained soft."
The main company pursuing promotions is the domestic upstart Luckin Coffee, which was founded as recently as November 2017.
According to WeChat, a Chinese social media site, Luckin is a serial discounter and often undercuts Starbucks' comparatively expensive business model.
The site states that two-for-three and five-for-ten coffee deals are standard and at least through 2018, all food is half price. The heavy discounting, made possible by the company founder Jenny Qian Zhiya's deep pockets. As the founder of ride-hailing service UCAR, she has publicly stated that she is not short of cash.
Additionally, Zhiya's company has partnered Chinese tech giant Tencent (TCEHY) , meaning that Starbucks' partnership with Alibaba Holdings (BABA) to dominate ecommerce is not an ace in the hole either.
Given the persistent undercutting by Luckin, market share amid an economic slowdown in China is certainly at risk.
Open Door to Chinese Competition
The growing middle class in China has meant that many companies outside of China are clamoring to get a piece of the market and take a shot at Starbucks' crown.
Costa Coffee, now under the Coca Cola (KO) umbrella, is the most notable contender.
The company currently operates 459 stores in China, but plans to expand its store offerings to over 1,000 in a short period of time. The rapid growth should curb the convenience lead that Starbucks maintains by its staggering number of locations.
Coke's deep pockets should also allow the company to expand rapidly and ramp up its ecommerce offerings, a vital way to appeal to Chinese consumers.
To be sure, Starbucks is still dominant in China as it controls 58.6% of the overall coffee market, generating $1.3 billion in revenues in the region last quarter.
While growth may slow down, it will certainly be difficult to make Chinese consumers kick Starbucks to the curb.
Trade War Hangover
Finally, the trade war seems to touch everything and it very well could stir up Starbucks.
Operating in China is a tenuous proposition for many United States-based companies amid the bluster emanating from both Beijing and Washington.
"A retaliation against US brands could impact sales [in China]," RBC's David Palmer said.
As an essentially totalitarian regime, the Xi administration could impose just about whatever sanction he chooses on Starbucks. That is a scary proposition if the trade war continues to ramp up and American corporations in China end up being the whipping boy that Chinese administrators take out frustrations on.
For now, that does not even seem necessary as a bubbling nationalism has already stung companies like Starbucks.
"There is a huge risk in general for American brands, but especially for iconic ones like Starbucks," said Shaun Rein, managing director at China Market Research Group told the South China Morning Post. "With increased competition, combined with nationalism, and the trade war as a back drop, it is very possible Chinese consumers will boycott McDonald's (MCD) and Starbucks and instead go to Chinese brands."
The trend could very well play right into the hands of Luckin again, as its already discounted prices satisfy pocketbooks and patriotism.
So, while the consensus is projecting a slightly positive impact on same store sales in China as the iconic brand regains its positive momentum, the amount of factors working against the Seattle standby make that a tall, or maybe Venti, order.