After Starbucks Corp. SBUX-Q announced a new chief executive officer on Tuesday, its share price jumped 24.5 per cent. Now comes the hard part: turning around the global coffee retailer after weak sales raised questions about whether the stock’s go-go days are over.
Tuesday’s rally, which lifted the stock to US$95.90, up US$18.87, suggested investors have given the incoming CEO, Brian Niccol – who was wooed from Chipotle Mexican Grill Inc. – the benefit of the doubt. The gains added US$21-billion to the chain’s market value in a single day, wowing observers.
“We have never seen a stock move as materially on a management change,” Gregory Francfort, an analyst at Guggenheim Securities, said in a note.
Clearly, this was no ordinary executive shuffle.
It followed disappointing fiscal third-quarter financial results on July 30. Global comparable sales at stores open for at least 13 months retreated 3 per cent from the same period last year, led by a 14-per-cent decline in China. Net earnings fell 7.6 per cent and operating margins contracted.
“We are not satisfied with the results, but our actions are making an impact,” then-CEO Laxman Narasimhan said during a call with analysts.
The previous quarter showed a similar trend, and patience among key investors may have been running thin with the share price down 21 per cent at the end of July, year-to-date.
Activist investor Elliott Investment Management had been demanding changes at Starbucks since earlier this year. Another activist investor, Starboard Value, added its voice more recently.
Perhaps more pressing, Howard Schultz, the longest-serving CEO and a significant shareholder, criticized the direction that Starbucks was heading in a LinkedIn post in May.
The question now is whether the change in leadership can solve two thorny issues at Starbucks – market saturation in the United States and rising competition in China – and turn this week’s share price gains into a sustainable rally.
The initial market reaction suggests that investors are optimistic, for at least one good reason.
Mr. Niccol’s six-year tenure at Chipotle Mexican Grill drove the share price up more than 940 per cent, as of June. He was credited for increasing traffic, fixing the company’s culture, improving operations and lifting profit.
In its second quarter, the company reported that its revenues increased by 18.2 per cent, year-over-year, and net income increased 33 per cent, with fatter profit margins.
“Mr. Niccol is an ideal fit for what ails Starbucks and brings instant credibility given his success in driving Chipotle Grill’s recovery,” Andrew Strelzik, an analyst at BMO Capital Markets, said in a note.
This appears to be a widely held view, given that Chipotle shares fell 7.5 per cent on the day that the company announced that he was leaving for Starbucks.
None of this leadership drama would matter if the coffee chain faced intractable problems that a CEO couldn’t fix. But that’s not the consensus view.
Mr. Schultz argued in his LinkedIn post that the solution was to focus on the customer experience, rather than relying solely on data. He also believes that Starbucks should put greater emphasis on coffee-based drinks when looking at new products to launch.
Mr. Strelzik, who doesn’t believe that Starbucks’s challenges are structural, expects that Mr. Niccol will take a page from his years at Chipotle and shift the company’s marketing strategy. That could entail moving from digital-focused advertising to something that could encompass television and other marketing channels, broadening the brand’s reach.
Jon Tower, an analyst at Citigroup, believes that the new CEO – who starts Sept. 9 – should shift strategic priorities from China to the United States, which drove about 70 per cent of revenue in the third quarter. He should also invest in improving the experience of both customers and employees, even if that comes at the expense of near-term earnings growth.
With a clearly defined long-term roadmap for growth within the next six months, “we think investors will be willing to look through a reinvestment era,” Mr. Tower said in a note.
Still, investors arriving late to this rebound face a couple of challenges of their own. After this week’s rally, the share price is down just 2 per cent this year, which suggests that a lot of optimism is already baked into the stock.
Similarly, the valuation is not cheap. The shares now trade at more than 20 times estimated earnings from analysts, according to S&P Global Market Intelligence. This is a valuation normally reserved for companies with highly visible growth opportunities, rather than flagging sales.
There’s good reason to believe new leadership can fix this mess. The risk is that the market has already skipped ahead to the part when it all pays off.