Starbucks Downgraded By Morgan Stanley After 'Negative Surprise' In Forecast

Starbucks Corporation SBUX said Tuesday afternoon in a third-quarter preannouncment that it needs to "move faster to address the more rapidly changing preferences and needs of our customers."

The coffee chain lowered its new store growth forecast. The discouraging announcement is "compelling enough" that Morgan Stanley dropped its bullish stance on the stock Wednesday. 

The Analyst

Morgan Stanley's John Glass downgraded Starbucks rating from Overweight to Equal-weight with a price target lowered from $72 to $59.

The Thesis

Starbucks guided Tuesday afternoon to a same-store sales shortfall in Q3, including flat comps in the important Chinese market, Glass said in the downgrade note. This is notable, as comps in China rose as much as 8 percent just three quarters ago — so the deceleration guidance is a clear "negative surprise," the analyst said.

While there may be "some plausible partial explanations" for the poorer-than-expected performance, the China business is now a "show me" story, Glass said. 

U.S. comps are likely to come in at 1 percent versus prior expectations of 3 percent, the analyst said. Tuesday's guidance also showed sales rebounded to positive 3 percent in June, but transaction growth is likely soft, he said. 

The Game Plan

Starbucks is taking proactive measures in response to a "clearer pattern of slower U.S. sales," including a greater focus on product and digital innovation, Glass said, adding that it's is difficult to estimate how much the initiatives impact sales.

The decision to slow down unit store growth from 5 percent to 3 percent may not represent a large enough reduction, he said. 

Morgan Stanley's firsthand coffee chain unit growth checks and research suggests that capacity in the industry has accelerated over the past two years to 5 percent. Starbucks accounted for half of the category's total unit growth, which implies that a slowdown in new openings is "constructive" but also underscores the maturation of the brand, Glass said.

Survey Results

Morgan Stanley's proprietary survey of 2,000 coffee drinkers, 1,300 of whom are Starbucks customers, offers additional insight as to why the stock should no longer be considered a buy, the analyst said. The findings from the survey include:

• Lighter Starbucks users — those who visit every few weeks or less — account for 40 percent of the user base but 60 percent of the traffic declines.
• Twenty-eight percent of users visit in the less attractive afternoon period versus the average peer set of 15-20 percent, which implies the company is in some ways "disproportionately hurt by its larger than average afternoon business."
• Even Starbucks' most loyal customers (27 percent) are open to switching to another brand over the next six months.

Price Action

Shares of Starbucks were trading lower by nearly 6 percent at $54.03, below the stock's 52-week low of $56.34.

Related Links:

Wall Street's Take On Starbucks Following Schultz's Departure

Analyst Doesn't Expect Starbucks Sales To Be Hit By New 'Third Place Policy'