Starbucks' (SBUX) bullishness in China is a a big reason why the stock is popping on Friday. But is it a promise?
Shares of Starbucks are rising strongly in early trading after an earnings release that touted the region as a key growth driver.
Factors include surprising forecasts, as well as same-store sales there ticked 1% higher in the quarter despite pressure from a slowing Chinese economy, and the Seattle-based brewer's status as a prominent emblem of America in the country.
"China represents a large opportunity and a dynamic market," CEO Kevin Johnson told analysts Thursday. "We remain bullish on our path in China and the growth that lies ahead, we are playing the long game in China."
Still, analysts were uncertain as to the company's ability to continue these results as the trade war drags on and stiff competition stirs the pot.
"We expect China performance to remain choppy given the increasingly challenging operating environment, which creates heightened risk as the stock's valuation already appears disconnected from its underlying growth rates," BMO Capital Markets analyst Andrew Strelzik said in a client note.
A lack of resolution to trade war, which was noted as "miles and miles away" by Commerce Secretary Wilbur Ross, adds uncertainty.Caffeine Competition
The company also has to contend with significant competition from both domestic and fellow international coffee purveyors aiming at the burgeoning market.
Most notably, Coca Cola's (KO) Costa Coffee acquisition aims to expand into the market and chip away at Starbucks' dominant market share.
The Coke-owned chain is setting its sights on over 1,200 locations in China which would certainly challenge the convenience advantage of Starbucks. Given Coke's deep pockets that now accelerates the effort, the build-out could come sooner than Starbucks initially anticipated and only adds to the more global play the beverage giant is leading with its inroad to Dunkin Brands' (DNKN) ready to drink beverages.
That is not to mention domestic upstarts like Luckin Coffee, which could benefit not only from patriotic purchasing, but from the consistent undercutting of Starbucks' pricey products.
Luckin Coffee, founded in 2017 by UCAR founder Jenny Qian Zhiya regularly offers two-for-three and five-for-ten coffee deals and food at half price, according to WeChat. The offers become especially difficult to contend with as the Chinese consumer buying power weakens amidst trade tensions.
"There is a huge risk in general for American brands, but especially for iconic ones like Starbucks," 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."
SBUX CEO Kevin Johnson addressed this with analysts Thursday, pointing to the company's resilience since entering the market in 1999.
"We expect competition to remain highly promotional and disruptive," he acknowledged. "As we have done over the past 20 years in China, we will continue to learn and adapt as we create a broader coffee culture, expand our presence in both new and existing cities, and deliver a differentiated Starbucks experience throughout China whether it's serving customers in our beautifully designed stores or enabling new channels like Starbucks Delivers."
For now, Starbucks' results suggest it can navigate this risk, but that is far from a "safe" long-term thesis.Make Mine Tea
Adding further pressure is the sustained strength of the tea culture and growth of more convenient milk tea options, which add to the crowded market for caffeine consumers.
A report from UC Davis notes that tea has long been the dominant beverage for those seeking a pick-me-up in the world's most populous nation.
"Although the total coffee consumption grew at 13-16% annually in 1994-2013, the proportion of drinkers remains small-increasing from just 1 percent of the Chinese surveyed to 3 percent in 2009," the report indicates.
Statista has charted that trend to remain disparate, with the volume of coffee to represent only 10% of the caffeinated beverages drank in the nation by 2020, with tea still commanding 90%.
While that is a significant growth rate, it is indicative of consumer sentiment still favoring what Chairman Mao once favored as toothpaste.
Milk tea, or bubble tea as its also known, is a key competitor as well given its more convenient appeal to Chinese millennials not interested in traditional Chinese tea ceremonies.
"Chinese now consume five times more milk tea than coffee," Bryan Loo, CEO of Malaysian milk tea leader Loob told Marketing to China. "After the arrival of pearl milk tea to China, coffee has taken a backseat. Bubble tea consumption in particular, continues to rise at a high rate each year. Therefore, the potential is huge."
Allied Market Research anticipates the Global Bubble Tea Market to expand to $3.2 billion by 2023, growing at a CAGR of 7.4% from 2017 to 2023, largely driven by demand in China. While that market share will remain significantly below coffee, the cannibalization risk remains.
While Starbucks is increasingly shifting its narrative on the growth engine to China and results are indicating unexpected success in the region, investors should not count it as a sure thing, especially as macro risks remain unresolved.
"We continue to believe theoretical growth drivers exist to sustain China same store sales growth at least towards the low end of 1-3% guidance, particularly as delivery begins to contribute," Wedbush analyst Nick Setyan observed. "Nevertheless, we remain cautious given near-term headwinds surrounding China, including cannibalization, increasing competition, a slowing economy, and the consolidation of the East China business within the overall China comp."
With that in mind, Starbucks may need to make investors certain they won't burn themselves on the Chinese coffee trade before they take a big sip.