Starbucks Discontinues Evenings: What It Means For The Bull Thesis

| About: Starbucks Corporation (SBUX)

Summary

Starbucks announced that it will end its Evenings program in over 400 company-owned stores.

Food remains part of the growth narrative because the Evenings program was never the protagonist.

This does not mean Starbucks will not revisit the dinner-time opportunity.

In early 2008, the coffee aroma central to the Starbucks (NASDAQ: SBUX) brand was nowhere to be found. Starbucks stores wreaked of a chain that had lost touch with its brand's authenticity and commoditized the customer experience. At least, that's what it smelled like to then-returning CEO Howard Schultz. To others, it just smelled like burnt cheese from breakfast sandwiches.

As a result of what Schultz called "the commoditization of the Starbucks experience" in an infamous leaked 2007 letter to staff, Starbucks announced its intention to stop serving breakfast sandwiches shortly after Schultz returned as CEO in 2008. Later that same year, the company reportedly found a way to prevent pervasive cheese scents and improved the taste of its sandwiches. And thus, today, customers can still order an egg and cheese sandwich with their coffee.

This history lesson serves two points: 1.) Growth must be balanced with a continued focus on the Starbucks experience, and 2.) An announced discontinuation does not spell an infinite end to a product category. Earlier this week, in a move that parallels the above moment in Starbucks history, the coffee chain announced that it will be shuttering its Evenings program, taking beer, wine, and food off its dinner menu at 439 company-owned stores.

With potential revenue growth from food offerings a part of the growth narrative - one I outlined a few weeks ago - any interruption to it can instill fear in shareholders. But the news does not disrupt the growth story behind Starbucks, as Evenings is an insignificant portion of the food category and can still be refined in the future to deliver growth.

The program's discontinuation manifests the challenges inherent in attempting to expand into new product categories. Surely Starbucks is an expert in coffee and tea, but becoming a leader in alcohol and fine dining will take time. As the company has learned before from products like the drinkable dessert Chantico, simply adding a product to the menu does not guarantee it will sell - no matter how well Starbucks is performing in other areas.

Shareholders may be quick to suspect a fall in comparable same-store sales, but the portion of sales Evenings delivers is insignificant. The below chart shows that Food's total portion of revenues in Company Operated stores remained flat since 2014, the year the company announced its ambitious plan to scale Evenings to over 1,000 stores. If Evenings were delivering the company's recent growth, it would be reflected in an uptick in Food's share of revenues.

Source: Starbucks Form 10-K Filing

The discontinuation does not challenge the idea that growth in food sales can lead to comparable same-store sales (comps) growth, because breakfast and lunch-time growth are the real comps drivers. I noted this fact when I included food sales as part of the company's growth story, pointing to the 17% increase in breakfast sandwich sales as reason for encouragement. Food is delivering growth, but that doesn't mean Evenings is the economic driver if breakfast and lunch are the segments carrying the torch.

In the Q4 Earnings Call, soon-to-be-CEO Kevin Johnson mentioned breakfast sandwich sales as the leader behind the one point of comp sales delivered by the food division. It was lunch, not dinner, that he focused on, saying "Lunch remains a significant opportunity as we amplify the strength of our Bistro Box platform through the Power Lunch offering. While we've made great progress around food in the lunch day part, we believe there is a significant opportunity."

While bears will surely point to Evenings' termination as a death knell for menu innovation at Starbucks, one doesn't need to search far for a counterexample: Last quarter, several fresh beverages (including the Coconut Milk Macchiato and Teavana Iced Berry Sangria) contributed a point of comp sales.

Investors may wonder how food can contribute to an increase in same store sales if its portion of company revenue remained flat. The below chart, which shows the consolidated revenue mix by product type, explains this phenomenon: overall revenue is growing, so in order to maintain share of revenue, food sales must increase as well. Food sales grew, causing comp sales to grow; food's overall share of revenue did not, because other components had skyrocketing sales.

If breakfast sandwiches sales declined over this time, there would be reason to assume Evenings was carrying the slack. But since breakfast sandwiches grew rapidly - 60% over the past two years - it is extremely unlikely that Evenings caused any significant revenue boost to the Food category.

Source: Starbucks Form 10-K Filing

Skeptics may be quick to ask how we can trust the company to deliver on its lunchtime opportunity and other opportunities if they seemingly failed at dinnertime. The answer to this lies within the 2008 breakfast sandwich story; Starbucks has a history of delivering growth, but it only occurs after learning from experiments. This history is not limited to breakfast sandwiches: the 1994 Mazagran evolved into the Frappucino, a major revenue driver; the 2008 Vivanno smoothie misstep is now overshadowed by Evolution Fresh Smoothies; and the experimentation with new store concepts, like the Roastery, is leading to more unique concepts and a new wave of high-end store growth.

This pattern of addition through a subtraction, followed by refinement, is unfolding with Evenings. Starbucks intends to incorporate wine and spirits into its high-end stores, according to a Dallas News article, a move that shows the company can take what it learned from its regular concepts and deliver a superior, authentic experience in its new, high-end stores.

With comp sales drivers still in place and Starbucks's ability to turn its institutional knowledge into future success, investors have no reason to fear following the Evenings discontinuation. The growth narrative remains undisrupted.

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.

Additional disclosure: I worked as a barista at a licensed Starbucks store.

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