Starbucks And Whole Foods: 2 Very Different Ways Forward

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About: Starbucks Corporation (SBUX), AMZN
by: Reuben Gregg Brewer
Summary

SBUX just announced that its longtime leader is stepping down as CEO.

He will be shifting his focus from the day-to-day business and onto a new growth initiative.

WFM, meanwhile, is struggling with weak same store sales and has also been looking at a new growth initiative.

The comparison between the two is enlightening.

Whole Foods Market (WFM) reported earning in early November. While it touted its top line growth, investors were far more concerned with the still floundering same store sales numbers. The question on everyone's mind is how is the high-end grocery store going to fix the problem? High-end coffee chain Starbucks (NASDAQ:SBUX), meanwhile, just announced that long time CEO Howard Schultz is handing over the day-to-day reigns of the company so he can focus on a new growth project. The difference between these two companies couldn't be more stark.

No comparison?

Clearly, Starbucks and Whole Foods are in very different businesses. You could easily argue that they simply can't be compared, but that isn't totally true. That's because both companies are trying to hit the same type of consumer, namely wealthy buyers. Sure, they sell different things but the target audience is identical.

There's also a notable overlap in the business environments each face. For example, one of Whole Foods' big problems is that the natural foods it sells are increasingly showing up in traditional grocery chains and Wal-Mart's (NYSE:WMT) stores. Starbucks' success in the coffee space has not only led to imitators, but pushed chains like McDonald's (NYSE:MCD) and Dunkin Donuts (NASDAQ:DNKN) to up their coffee offerings. In other words, the low end is starting to compete with both Whole Foods and Starbucks.

So while the businesses are very different, the backdrop is very similar.

The struggle

Whole Foods has been having a much harder go of things than Starbucks. To put that in perspective, Whole Foods has seen same store sales fall for several quarters. In the most recent period the drop was 2.6%. The real dilemma is at stores that have been open for five years or longer, same store sales declines for these units is down over 3% and they represent a hefty 70% of its square footage.

To be fair, the top line continues to grow. However, that's because of new store openings. A retailer can live with weak same store sales results being covered over by new store openings for a little while, but it can't continue that trend for too long. A long trend of weak same store sales signals that there's something materially wrong.

Starbucks, meanwhile, saw same store sales advance 4% in its most recent fiscal year, ended October. That's half of what it was in the previous fiscal year, but a far cry from the contraction that Whole Foods is seeing. So, in many ways, Starbucks is in a stronger position. That said, neither company is in danger of financial distress. But they are taking vastly different approaches to the future and that's worth thinking about.

Getting cheap, getting expensive

Starbucks and Whole Foods both offer relatively costly products; note the running joke about Whole Foods name actually being Whole Paycheck. And while I can't imagine paying more than a buck for coffee, there's always a line at Starbucks filled with people willing to spend $5 or more for a cup of wake me up. Both companies have, historically, done a good job of differentiating themselves with both product, service, and atmosphere.

Faced with headwinds, however, Whole Foods has started to shift down toward its competitors. It has cut jobs (risking service quality), cut prices (which pressures margins), and opened up a new format built off of its store brand. In other words, it's starting to look more and more like just another grocery store. That's a notoriously low margin business filled with intense competition. It carved out a high-end, and high margin, niche, but the choices it's making today could put that at risk.

Starbucks, on the other hand, has just announced a leadership change that will free up Howard Schultz to focus on a brand concept that's even higher end than what the company offers today, called Reserve. Essentially, it's a store meant for true coffee snobs willing to pay up for their caffeine addiction. The company thinks it can open up to 1,000 of them. This isn't a rush, however, with the near-term goal being six stores by the end of 2019.

It's obviously too soon to tell which company is going down the correct path. What's interesting, however, is the difference between the two approaches. Whole Foods is shifting away from what made it special by reaching down and Starbucks is embracing what made it special by reaching up.

Watch closely

If you own or are watching either of these companies, monitor the new initiatives closely. They will be a key determining factor in how much growth you can expect from each of these largely established companies going forward. Note, however, that the weak same store sales numbers at Whole Foods means that the pressure to succeed is much higher at the grocery chain.

In fact, I've long been concerned about Whole Foods cheapening its brand, so I'm not a big fan despite the company's solid profitability. I'm far more excited about Starbucks' move, especially since Schultz is stepping back from day-to-day operations to take the lead. It builds off of a strong core and enhances the brand image. Although I don't own either, I'll be watching this interesting dichotomy with the expectation that Starbucks has chosen the wiser path.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.