Last week, Starbucks (NASDAQ:SBUX) reported its third quarter results after the bell on Thursday. Personally, this was one of my highly anticipated reports this earnings season. Last month, I started to reestablish my long position in the company. Heading into the quarter I set aside cash to add to my position on a pullback.
Shares of Starbucks traded immediately to the downside in after hours trading on Thursday. I was able to add to my long position at $56 per share. However, shares quickly rebounded to $58 and finished 0.50% higher on Friday.
From first look, the quarter looked lackluster. Starbucks reported third quarter earnings of $0.49, in line with analyst estimates. And on the top line, the company missed by $130 million with revenue of $5.2 billion.
But when you look beyond just the headline numbers, the third quarter report was actually quite good.
Rewards = Loyalty
Over the last few years, the company's Rewards program has been a big focus and driver of loyalty. Heading into the quarter, Starbucks had 12 million Rewards members in the U.S. In the third quarter, Starbucks added 300,000 net new Rewards members in the U.S.
Rewards members are an extremely valuable asset for the company. According to the conference call, Rewards members typically drive higher revenue growth, vs. non-Rewards members. And, in my own analysis I've concluded that Rewards members have a much higher level of inelastic demand, vs. non-Rewards members.
Earlier this year, Starbucks revamped the Rewards platform. Starbucks now determines Rewards on the basis of total amount spent, vs. total number of transactions. In the conference call management was positive when commenting on the changes:
The shift was a one-time event, a once-in-a-decade change built on carefully vetted analysis that showed that a spend-based program would best reward our most loyal customers and encourage all of our customers to visit us more often and spend more on each visit, and it would be more fair for all of our customers as well.
And in China/Asia Pacific, Starbucks now has over 19 million Rewards members. In China alone, the company has over 10 million Rewards members.
Investment in the Rewards program is a long term investment. Starbucks is creating, arguably, the most loyal customer base in the quick service restaurant industry.
Mobile Order & Pay
Starbucks Rewards program is built on the company's mobile application. Starbucks has done mobile better than any of its competitors, and better than any quick service restaurant company.
The company's Mobile Order & Pay business increased by 20% year over year. Mobile Order & Pay now represents a whopping 5% of all U.S. transactions, and nearly 20% of all mobile payments at Starbucks.
If you live and work in a busy city, like I do, you know the power of Mobile Order & Pay. My local Starbucks locations are usually packed on the way to work in the morning. But with Mobile Order & Pay, I can have my drink waiting for me, and not the other way around. Mobile Order & Pay is unlocking capacity at busy Starbucks locations. On the conference call, the company reported that Mobile Order & Pay represents more than 20% of all transactions at peak hours at some locations.
The company's Channel Development segment grew by 9% year-over-year. Starbucks maintained its leadership role in the K-Cups market. The company now holds a 15.8% share of the K-Cups market.
Ready-to-Drink was also strong in the third quarter. Starbucks increased market share by 1% in the competitive liquid coffee plus energy segment. Today, the company has a 13.3% market share in the total liquid coffee plus energy segment.
Starbucks should continue to do well in Ready-to-Drink. The company's Teavana Ready-to-Drink teas are now expected to launch in the first half of 2017. And, the company's Cold Brew Ready-to-Drink just launched in July. If the Cold Brew Ready-to-Drink beverages are half as good as the in-store variety, the product will do very well.
Channel development is an important piece of the long term Starbucks growth thesis. Channel development is diversifying and growing revenues.
China China China
Starbucks shares rebounded in large part to the company's success in China. Starbucks China/Asia Pacific region was strong with year-on-year revenue and operating income growth of 18% and 22%, respectively. Comparable sales in China/Asia Pacific grew by 3% in the quarter, with China comp accelerating to 7%.
Starbucks has invested heavily in CAP, with more than 2,200 stores in Mainland China, and over 6,100 stores across CAP. Management was bullish on China on the conference call:
Our newest China stores continue to deliver record-breaking volume and profit, and we remain committed, and we're on plan to increase our store count to over 3,400 in China and to over 10,000 in CAP overall by the end of fiscal 2019.
Rising incomes is giving the company the ability to expand into additional medium and small markets in China. And as mentioned above, Starbucks now has over 19 million Rewards members in China/Asia Pacific.
China is the cornerstone of the long term bull thesis. The results from last week give me confidence that the company is headed in the right direction.
Overall, the quarter was good. Hopefully you were able to add to your Starbucks position on the quick pullback.
Disclosure: I am/we are long SBUX.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.