Will China Crimp Starbucks' Growth Plans?

By 百楽兎 (File:Chinese Dragon Banner.svg) [CC0], via Wikimedia Commons

Source: flickr user Rob.Bertholf under Creative Commons license.

A change in policy

On August 11th, the Chinese central bank adjusted the daily midpoint trading range of its currency, the yuan, against the U.S.

dollar.

Source: flickr user upton under Creative Commons license.

Yuan devaluation

This move effectively devalued the yuan. The Chinese government did so in part to make its exports more competitive, to combat the a slowdown in its manufacturing-based economy.

In the three weeks since devaluation, the yuan has dropped roughly 4.1% versus the U.S. dollar.

However, the maneuver increased uncertainty around the Chinese government's monetary policy, which in turn exacerbated a fierce correction in the country's stock market, underway since June:

A frantic sell-off in China's stock market

Challenging conditions

Taken together, a slowing Chinese economy, a weaker yuan, and a shaky stock

market have the potential to crimp Starbucks' growth plans in China.

China is central to Starbucks' future

Starbucks currently has 1,700 stores in China.

Along with Japan, China anchors Starbucks' China/Asia Pacific, or CAP, business segment.

"Jinli St. Starbucks" by Flickr user Claire Rowland under Creative Commons license.

The powerful CAP segment can impact overall results

CAP is a tremendously successful operating segment. In the most recently reported quarter:

•Comparable store sales growth of 11%•Revenue growth (after adjusting for acquisition of Starbucks Japan) of 20%•Operating income of 23%•13.3% of total Starbucks revenue•12.8% of total Starbucks operating income

Starbuck's ambitious CAP goals

The company is counting on China to be the engine that powers the following ambitious goals in the CAP region:

In the next five years, Starbucks wants to:

• Nearly double total CAP store count from 5,500 to 10,000

• Triple CAP revenue to $3 billion

• Triple CAP operating income to $1 billion

A clear path, or trouble ahead?

Starbucks' Chinese expansion, as well as its CAP expansion, is threatened by the three emerging obstacles to growth mentioned earlier. Let's examine them a bit more closely on the following slides.

Shibuya Crossing Starbucks, Tokyo, Japan, one of the CAP region's most famous stores. Source: Flickr user Dick Thomas Johnson under Creative Commons license.

Obstacle #1: A downshifting economy

China's GDP is forecasted to slow from a current 7% annual rate to 6.5% or lower in the coming year.

Official statistics from the Chinese government are notoriously opaque, however. Some economists believe that the Chinese economy is decelerating much more quickly, and peg true current GDP growth at between 4%-5%.

A less vigorous economy hurts confidence

Softening GDP growth may affect consumer confidence, resulting in curtailed consumption of higher end goods such as Starbucks coffee, which sells at a premium price point in China versus other countries.

Source: flickr user Tom Thai

Obstacle #2: Yuan weakness

A depreciating yuan increases costs for Starbucks in China.

Starbucks can counter this effect by raising prices in local currency, but shifting its already lofty price points may hurt sales.

It can do simply do nothing and absorb the currency differential, but this will drag on operating income.

The Yuan also affects other Asian currencies

A pile of Thai bank notes. Source: Flickr user Karn B under Creative Commons license.

China's yuan devaluation has sparked fears of a currency war in Asia, as other Asian countries seek to maintain their export competitiveness.

Widespread Asian currency depreciation would put additional pressure on Starbucks' CAP segment.

Obstacle #3: The stock market

In China's stock market, retail investors are estimated to account for as much as 90% of daily turnover.

With so much of equity turnover in the hands of individual shareholders, many of whom are new investors, further declines may end up illustrating the "wealth effect."

The wealth effect

This is when a perceived or real decline in personal assets affects consumer behavior. If you're losing in the stock market, even if your losses are unrealized, you may begin to spend less as you perceive your wealth to have decreased.

Purchases not thought to be necessities (for example, a comparatively expensive cup of coffee!) are often the first consumption traits to fall victim to this effect.

A parting thought: implications for investors

1. It may be wrong to assume that China will provide an automatic boost to company financials over the next few quarters.

2. Pay attention to store openings, revenue growth, and operating income in the CAP segment for at least the next year.

3. Expect that management may recalibrate some of its CAP growth assumptions, and overall company goals, if the obstacles persist or strengthen.

Image of wall in Starbucks OCT East, Shenzhen, China, by Ged Carroll under Creative Commons license.

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