Early on Aug. 13 -- before I even started sipping my second cup of coffee -- Starbucks(NASDAQ: SBUX) shockingly announced that it hired Brian Niccol as its new CEO. Niccol has been CEO of Chipotle Mexican Grill(NYSE: CMG) since 2018. Shares of Starbucks soared on the news and I don't believe it's an overreaction in the least.
Starbucks stock had been down roughly 40% from highs reached in 2021 and I (mostly) fault management. In September 2023, longtime CEO and board member Howard Schultz officially stepped down from his third tenure as CEO. But while he refrained from taking up the mantle a fourth time, he publicly voiced his concerns over the coffee giant's direction in his absence.
Simply put, traffic is slipping at Starbucks, particularly at U.S. locations. The company's fiscal 2024 started back in October. And during the fiscal second quarter and the fiscal third quarter, U.S transactions were down 7% and 6% respectively.
As Schultz pointed out in a post on social media earlier this year, it wasn't so much the numbers that were the problem for Starbucks -- bad quarters happen no matter how good management is. The problem was whether management could correctly pinpoint the problem to correct it. And there was reasonable doubt that Starbucks' management was on the right track.
Starbucks is now taking drastic action to fix its problems by handing the reigns to a proven operator and problem-solver in Niccol.
Why this may be the news that Starbucks shareholders have been waiting for
When Niccol walked away from Yum! Brands' Taco Bell to join Chipotle Mexican Grill in 2018, he had incredibly large shoes to fill. Founder and CEO Steve Ells had nurtured his beloved restaurant concept into a hot chain with more than 2,400 locations. But while Ells had been an exceptional visionary, he did have his share of struggles.
Chipotle's systems and processes were often found wanting, which had led to regular virus outbreaks at its restaurants. By comparison, things were much more under control during Niccol's leadership.
Moreover, profitability skyrocketed for Chipotle with Niccol in the CEO chair. In 2017 (the last full year before Niccol), the company had a profit margin of just 4%. By comparison, its profit margin was over 12% in 2023 and over 14% in the first half of 2024. This operating leverage is spectacular and Niccol deserves a lot of credit for his leadership.
CMG Profit Margin data by YCharts
Niccol is a worthy hire for a brand as iconic as Starbucks. But this is clearly a shocking hire nonetheless. For context, CEO Laxman Narasimhan only took over completely in March 2023 after an orderly succession plan that started in September 2022. In other words, Narasimhan was the result of a clear, methodical plan. But the company is now moving on after a mere 17 months.
According to Narasimhan, Starbucks was struggling to attract new customers to the brand because those potential customers didn't like the value proposition. Therefore, to stimulate sales growth, the company was trying to offer more promotional pricing to bring people in.
By suddenly ousting Narasimhan and poaching Niccol from Chipotle, the board of directors apparently disagreed with the current direction of Starbucks, likely to Schultz's relief.
To be fair, Niccol's situation with Starbucks may not be as straightforward as the situation with Chipotle in 2018. For its part, Chipotle's struggles were self-inflicted. But for Starbucks, this admittedly is a challenging operating environment for all players. For example, McDonald's and other fast-food giants are currently in a value-pricing war, offering more and more bargains to bring diners in.
That said, it's worth noting that Chipotle hasn't joined its peers by offering promotional pricing. And according to Schultz, Starbucks needs to reinforce its "premium position" with consumers. Given Chipotle's ongoing premium prices, perhaps Niccol will also be able to keep Starbucks' menu prices higher than peers without pushing customers away.
Fortunately, I believe Starbucks has some low-hanging fruit that Niccol can quickly pick. Roughly 60% of the company's business comes from its base of nearly 34 million rewards customers. But in Q2, management noted a double-digit drop in order completions, meaning customers ordered on the app but failed to ultimately pick up their order.
Starbucks' management said that these customers primarily cited long wait times and order accuracy as the reasons they didn't complete their order. To be fair, management noted an improvement in Q3. But this is an operational problem that's frustrating the brands' most loyal customers.
If Starbucks can quickly fix this operational issue, it would go a long ways to reinforcing that premium brand position. In my opinion, this should be one of Niccol's first orders of business and it's something that investors can watch with high expectations in coming quarters.
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Jon Quast has positions in Starbucks. The Motley Fool has positions in and recommends Chipotle Mexican Grill and Starbucks. The Motley Fool recommends the following options: short September 2024 $52 puts on Chipotle Mexican Grill. The Motley Fool has a disclosure policy.
