Bank of America Advocates for Starbucks China Spin-off Strategy

Author: Owen Jenkins Updated: 09-18-2024 12:37 PM

Bank of America Calls for a Starbucks China Business Spin-off

In a noteworthy analysis, Bank of America has put forth a compelling suggestion for Starbucks (NASDAQ: SBUX) to spin off its China operations, considering the growing volatility and the challenges it faces compared to other markets. Analysts have noted that the China segment has experienced lower profitability and slower growth, prompting this recommendation.

Current Performance of Starbucks in China

The analysts pointed out that from 2010 until 2017, the China-Asia Pacific (CAP) segment of Starbucks showcased impressive same-store sales growth (SSSG), averaging around 10%. However, the landscape has shifted significantly in recent years.

Post the COVID-19 pandemic, the SSSG for Starbucks China has hit a worrying average of -3%. Moreover, the store EBITDA has plummeted by nearly 40% since its peak in early 2021, underlining the stark changes in market dynamics.

Market Growth and Consumer Behavior

While Bank of America reiterates that Starbucks remains well-positioned in China, it also acknowledges that the overall market growth has considerably slowed. The analysts remarked, "Starbucks is still advantaged, but market growth has moderated." This moderation coincides with sluggish GDP growth in China, a factor that is closely tied to Starbucks' performance in the region.

Deflationary pressures in the market have also resulted in negative ticket growth, signaling that consumers are not spending as they once did. Although coffee consumption is on the rise, it still pales in comparison to other Asian markets, notably Japan, which raises concerns about the growth potential within China.

The Case for Licensing Model in China

Bank of America suggests that spinning off the China business to adopt a licensing model could provide a solution with limited adverse effects on Starbucks' financials. Licensing stores tend to yield lower margins, but they can still contribute positively to overall profitability.

This shift in strategy could help decrease market volatility, ultimately enhancing Starbucks' return on investment (ROI) in the region. Additionally, it would enable management, especially new CEO Brian Niccol, to focus more on the lucrative U.S. market, which currently represents 73% of the company’s EBITDA before corporate expenses.

Future Prospects and Price Target

In conjunction with these insights, Bank of America has increased its price target for Starbucks to $118, highlighting a renewed confidence in the company’s strategic execution. Moreover, they have raised the earnings-per-share (EPS) estimate for fiscal 2027, projecting a steady-state comparable sales growth rate of 4%, up from the previous estimate of 3.6%.

The conclusion drawn by the bank posits that a strategic spin-off of the China operations would not only lead to improved returns for Starbucks but also alleviate managerial pressures. This would allow the company to focus its efforts on their primary market in the U.S., fueling its continued growth moving forward.

Frequently Asked Questions

What is Bank of America's recommendation for Starbucks?

Bank of America suggests that Starbucks should consider spinning off its China operations due to challenges like lower profitability and slower growth.

How has Starbucks' performance in China changed post-COVID?

After COVID-19, Starbucks in China faced a decrease in same-store sales growth, averaging -3%, and a significant drop in store EBITDA.

What impact would a spin-off have on Starbucks' financials?

A spin-off could have a limited impact on Starbucks' financials, potentially shifting to a licensing model that may reduce volatility and improve ROI.

What percentage of Starbucks' EBITDA comes from the U.S. market?

The U.S. market accounts for approximately 73% of Starbucks’ EBITDA before corporate expenses.

What is Bank of America's new price target for Starbucks?

Bank of America has raised its price target for Starbucks to $118, reflecting increased confidence in the company's execution and future performance.

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