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Is the Starbucks Success Story in China in Danger?

Starbucks has done well as a company thanks in no small part to its rapid expansion in mainland China. But it looks like its days of explosive growth in the country might be slowing down notably.

Starbucks was an early mover in the country, opening its first store in 1999. Somewhat surprisingly for this nation of tea drinkers, the mainland went wild for the company’s twist on traditional espresso drinks almost from the beginning. This helped fuel Starbucks’ overall growth, which allowed it to expand into the near-ubiquitous presence it is in many cities around the world. In fiscal 2016, the company booked net revenue that was well higher than only four years previously. And the company’s China/Asia Pacific (CAP) region was a jolt of caffeine within those results, coming in several orders of magnitude higher than the overall result.

That feels too good to last, and it hasn’t — in the four-year stretch from 2014 to 2018, CAP delivered net revenue growth. While still robust, these growth rates weren’t nearly as impressive.

The China challenge

Starbucks recently started to report more modest results in CAP, most of which is driven by its business on the mainland. In fiscal 2018 the critical metric of same-store sales (i.e., sales in Starbucks outlets that have been open at least 13 months) crept up only slightly, though other regions also showed weaker same-store sales. For Q1 of 2019 Starbucks broke out individual results from China, which revealed a similar dynamic.

Yes, “comps” are rising (a bit) lately, but nowhere near at the rate they were previously. In fiscal 2012, for example, CAP same-store sales rose mightily.

Starbucks management likes to point to its revenue improvement in China as a sign of its strategic success. Yes, it was nice to see a healthy increase in Q1 2019. But in fiscal 2013, not exactly a long time ago, the company was delivering top-line regional growth that was well higher.

Perhaps the biggest culprit for the recent slowdown is plain old competition. If a good idea (like coffee) is an obvious hit with local customers, there will inevitably be some people or businesses that come along to emulate it — and fast. Sure enough, Starbucks is hardly the only big game in town anymore. For example Luckin Coffee quickly became a presence, opening more than 500 locations throughout the mainland less than a year after its founding in 2017. Luckin’s stores are smaller, as a rule, which saves on costs. It also only permits customers to transact through its mobile app, through which it also bestows loyalty points for purchases. This is a stickier ecosystem than that of Starbucks, and it might be resonating better with young clientele who grew up on mobile technology.

Luckin, of course, is not the only rival selling coffee. Gourmet Master’s 85°C Bakery Café has been a presence on the market for years, while fellow U.S. corporate giant McDonald’s slings plenty of lattes through its McCafe brand of offerings.

Upsizing

Despite the more difficult environment, the company is doubling down on its efforts in the mainland. In early 2018 it acquired the 50% of the President Starbucks Coffee Taiwan joint-venture it didn’t own. That entity is the holding company for Starbucks coffee shops in Shanghai, Jiangsu, and Zhejiang provinces.

This matters – Shanghai alone had over 600 of these outlets at that time, the company’s largest store count in any city in the world (including municipalities in its native U.S.). The arrangement was also the largest deal Starbucks has made so far, costing $1.4 billion.

Following that, CEO Kevin Johnson made the apparent official, revealing that Starbucks had set mainland China as a strategic priority.

Say this for Starbucks — it’s a persistent company, and it doesn’t give up easily. But given that as recently as fiscal 2015 it was booking nearly double-digit comps on the mainland rather than the recent incremental rise, its days of easy growth there might just be a thing of the past.

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Disclosure: Motley Fool Hong Kong is not licensed by the Hong Kong Securities and Futures Commission to carry out any regulated activities under the Securities and Futures Ordinance. Eric Volkman doesn't own any shares mentioned above.