Capital Flows and Asset Markets
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Are people really ditching Starbucks, but sticking with Chipotle and Dominos?

I have said that the market price is truth. The problem with the market being the truth, is sometimes it tell you different things. I recently discussed the issues with Domino’s where its franchisees were suffering, while the parent company stock was surging. This possibly suggests that it has not raised prices with costs, to drive market share, which is causing margins at franchisees to fall. I like this analysis, and would suggest that restaurant businesses that don’t franchise should be clobbered. This has been the case for some chains for awhile. The Restaurant Group in the UK, which includes the Wagamama brand, fell more than 90% before being acquired by Apollo last year.

Recently, Starbucks reported a fall in revenue, and the stock fell to levels first seen in 2018.

Starbucks does not franchise to the same degree as McDonalds or Dominos. That is it is much more open to margin squeeze from rising costs.

So this would suggest that the margin squeeze is on, and would explain why we have seen a number of deals by franchisors to buyout franchisees. Better to keep these stores running, than have the franchisees go bankrupt. The problem with this analysis is that 100% company owned fast food chain, Chipotle, announced fantastic numbers. Stock is up 37% this year, and has a market cap that is greater than Starbucks now. The market is asking me to believe that people are ditching their frappuccinos, but sticking with their burritos?

What is odd, Tim Horton’s, a Canadian based coffee brand which is owned by Restaurant Brands International, reported no slowdown.

When I go through all the various listed restaurant chains, there is no consistent message. All reporting raising prices, but only some report falling volumes. Starbucks is one of those brands. My problem is that after growing up in Australia, I find Starbucks coffee fairly pointless. I never drink it, so I can’t tell if it has suddenly deteriorated. One thing I have noticed about Starbucks, is that it does badly whenever Howard Schultz is not in charge. This points to two possible reasons for Starbuck’s recent weakness. The first is Howard Schultz is a genius, and in the uber competitive world of coffee shops, without Schultz, Starbucks just become a bit mid. The second option is that restaurant brands have a life cycle. They invest to make the shops look great, and have a great menu, and once sales picks up they make great money for a while, but then the cycle turns again, and sales drops, and investment has to rise, and the stock does poorly. Howard probably knows this, and chooses to step down just before the down cycle hits to let some other shmuck take the hit. Current CEO, Laxman Narasinham was appointed in April of 2023, not far off the peak. Note Schultz returned at CEO in 2008, at a low ebb in the stock after being retired for many years. These two reasons are not mutually exclusive.

What I was hoping to find with Starbucks was the beginning of the end of the financial engineering of fast food chains. That problems with the franchisee model were beginning to exert themselves, and stocks like McDonalds would be great shorting opportunities.

That may end up being the case, but so far the Starbucks problems look to be just Starbucks problems. Is the real problem is that USD 5 for Caffe Latte when you can make it using Nespresso equipment at your home or office has just proved to much? Or working from home hurts Starbucks more than other brands? Or maybe its exposure to the China market has become a problem. Yum China (KFC China operations) has been very poor. However, China is only 8% of sales for Starbucks.

I don’t know what is exactly wrong with Starbucks - but something is definitely going wrong. I would be cautious on the stock, unless we suddenly see Howard Schultz return as CEO.