Starbucks saw an improvement in its same-store sales, but profitability fell short of expectations.
The company is investing in labor, which has driven up expenses.
While its labor investments lowered profitability, it is the right move over the long run.
News of some progress in turning around its lagging same-store sales was not enough to keep share prices of Starbucks(NASDAQ: SBUX) from dropping, partly because its fiscal second-quarter earnings fell well short of expectations. The stock now trades below the initial surge it experienced following the announcement that former Chipotle head Brian Niccol would assume the position of CEO.
Niccol was not left with an easy task, and he has decided to invest in human labor over just equipment as a way to increase efficiency and enhance the customer experience. This was something that I wrote needed to be done before he took over, even though it would lead to higher expenses, and something I predicted Niccol would do back in September.
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The decision led to higher expenses in the quarter, with store operating expenses climbing 12% year over year and increasing to 47.7% of revenue compared to 43.5% a year ago. Starbucks' overall operating margin contracted 450 basis points to 8.2%, which it said was largely due to the "surgical addition of labor into [its] stores."
Starbucks' stores were understaffed to reduce costs under its old leadership, which just wasn't sustainable. On its earnings call, Niccol noted that the company had previously been removing labor from its stores in the hope that equipment would offset the removal. However, he said that "investments in labor rather than equipment are more effective at improving throughput and driving transaction growth."
As a side note, one of the most amusing things on the earnings call was an analyst saying they thought that the company had been investing heavily in labor over the past few years. Apparently, they weren't doing a lot of in-the-field research.
Perhaps not surprisingly, then, the increased expenses seemed to catch analysts by surprise. The end result was that Starbucks' adjusted earnings per share (EPS) fell 40% year over year to $0.41 and badly missed the $0.49 analyst consensus, as compiled by LSEG.
Same-store sales improvement
On the bright side, Starbucks' investment in labor appears to be having an early positive effect on its same-store sales. While the company saw its comparable-store sales fall for the fifth-straight quarter, the 1% sales decrease was actually an improvement from recent quarters. Global traffic fell 2%, while it saw a 1% increase in the average ticket.
In North America, its comparable-store sales edged down 1%, with traffic down 4%. International same-store sales, meanwhile, rose 2%, with traffic increasing 3% and its change in average ticket down 1%.
Its second-largest market, China, saw flat same-store sales, with a 4% decline in average ticket and a 4% increase in traffic. The company credited product innovation and marketing efforts for the improvement. Meanwhile, Niccol said Starbucks remains committed to growing its China business over the long term.
Overall revenue rose 2% to $8.72 billion as it continues to increase its store base. That fell just short of analyst expectations for revenue of $8.82 billion, as compiled by LSEG.
Moving ahead, the company will continue to focus on menu innovation, with new product launches, such as its Cortado platform and summer berry refreshers with pearls, while also leaning into brand marketing. The company is trying to manage tariffs by localizing products where it can. Coffee is only about 10% to 15% of its overall product expenses; it's using hedges and sourcing strategies to minimize the impact of tariffs and pricing volatility.
Image source: Getty Images.
Is it time to buy Starbucks' stock?
Niccol had to make the difficult decision to increase labor to enhance the customer experience. While this will pressure profitability in the near term, it is the right long-term move. He needs to improve Starbuck's brand image to draw in customers and keep them coming back, and not just look for a quick fix. As sales begin to increase from these efforts, the company will eventually begin to show operating leverage and improved profitability.
Looking at valuation, the stock has a forward price-to-earnings (P/E) ratio of about 27.5 based on fiscal 2025 analyst estimates. That's generally in the range of where the stock has traded over the past few years. The stock is not in the bargain bin, but it's at one of the most attractive valuations it has been at since Niccol has taken the helm.
If you're looking for a quick turnaround at Starbucks, you may be disappointed. It was never going to be a quick fix. However, I think Niccol is making the right moves, and the stock will be better off in the long run.
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Geoffrey Seiler has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Chipotle Mexican Grill and Starbucks. The Motley Fool recommends the following options: short June 2025 $55 calls on Chipotle Mexican Grill. The Motley Fool has a disclosure policy.
