Last week, Bill Ackman’s Pershing Square Capital Management revealed at a conference that it owns 15.2 million shares of Starbucks Corp. And he revealed a bullish case for a company that has faced a frustrating slowdown in its traffic in recent years.
Ackman is no stranger to the restaurant business. And he doesn’t hunt small game.
He is on the board at Chipotle Mexican Grill and helped push changes there that led to the hiring of Brian Niccol as its CEO. He is a big investor in Restaurant Brands International, where he strongly endorses the Burger King owner’s method of low-cost, franchise-heavy management of fast-food chains. In past years, he has agitated at companies such as McDonald’s.
In this instance, he is taking on a company in need of a jump-start in its U.S. business. Same-store sales have been decelerating for the past couple of years, and traffic has been weak.
The company is already making some significant changes. As my colleague Heather Lalley noted last month, Starbucks is making major organizational changes, including layoffs, in a bid to “increase the velocity of innovation.” It is also bringing in Patrick Grismer to be its CFO.
But Starbucks has a lot going for it, particularly some impressive unit economics and returns on new locations.
For instance, both Starbucks and Taco Bell generate about the same amount of store-level EBITDA, or earnings before interest, taxes, depreciation and amortization ($450,000 for Starbucks, $480,000 for Taco Bell).
But Starbucks does that in a shop that costs $680,000 to build, half the price of a Taco Bell, and with average unit volumes of $1.5 million, compared to just less than $1.8 million for the Mexican chain (a strong performer in its own right).
Thus, Ackman said, it takes just one and a half years for Starbucks to get payback on that new unit, compared to just less than three years for Taco Bell.
And Starbucks has better returns on new units in China, where payback takes just 1.2 years, compared with 1.7 years for a KFC. (No wonder those companies are so eager to develop there.)
He believes that Starbucks in China will grow twice as fast as the company’s overall earnings and will account for 17% of company earnings by 2022, compared with 13% today. But he also believes Starbucks has plenty of room to grow in the U.S., where it is underpenetrated in the Midwest and the South.
Ackman indicated that more than $100 billion in coffee-related acquisitions have been completed since 2012, at valuations averaging 20% more than Starbucks’ current valuation.
Still, weakening U.S. same-store sales have been a problem for the company, whose stock is down more than 4% year to date even though its per-share price is up about $8 since June.
Ackman believes that increased competition, traffic congestion from mobile ordering, afternoon weakness because of a “lack of food innovations,” sales cannibalization from licensed units and a change in the company’s loyalty program have all contributed to the problem. The chain shifted to a spend-based loyalty program from a transaction-based system in 2016.
Starbucks is taking a number of steps to fix its sales challenges, including premium products, boutique concepts, an improved mobile ordering system, healthier beverages, improvements to the loyalty program and improved management of the business.
But it also includes a slowdown in U.S. licensed growth in key markets.
Indeed, Starbucks should consider a slowdown, period. As Bernstein research analyst Sara Senatore noted recently, the domestic traffic slowdown has coincided with a ramp-up in unit growth.
Ackman, for his part, endorsed many of the company’s existing moves, saying that CEO Kevin Johnson’s recent actions have been “encouraging.”
“We believe Starbucks’ recent challenges are fixable with appropriate management execution,” Ackman said in the presentation. And he believes that the potential is big: If same-store sales improve and valuation reverts to historical levels, Starbucks’ stock price could double.