Starbucks Pulls Guidance as Promotions Fail to Drive Traffic. Should Investors Worry?

Starbucks' (NASDAQ: SBUX) problems did not suddenly go away when it named Brian Niccol as CEO, despite his track record at Chipotle Mexican Grill. That fact reared its ugly head when the company decided to release a snapshot of its poor quarterly results ahead of its actual earnings report.

The stock initially reacted negatively before rallying to close the day slightly in positive territory. The market action shows that investors are willing to give Niccol some time to enact his turnaround plan.

Let's take a closer look at the coffeehouse operator's preliminary earnings and Niccol's comments to see when a turnaround might be coming.

Things got worse

While Starbucks has been struggling, things only got worse in its fiscal fourth quarter that ended in late September. One of the biggest measures of the health of the brand is its same-store sales, which shows how well sales are performing at established locations.

For Starbucks, this metric showed things aren't going too well. The company's overall same-store sales sank by 7% in the quarter. Both the U.S. and China continued to be the main drags on the company. In the U.S., Starbucks saw its same-store sales decline by 6%.

More troubling, though, is that traffic, or comparable transactions, fell 10%. This was despite the company increasing promotions to try and drive traffic to its stores. It said that more frequent in-app promotions and integrated marketing did not change customer behavior. The decline in traffic was somewhat offset by a 4% increase in the average ticket.

The company said that its efficiency efforts were going as planned, but it was not enough to overcome the traffic declines.

Meanwhile, things were no better in its second-largest market, China. Same-store sales in the country plunged 14%, with a 8% decline in traffic and a 6% decrease in average ticket. Starbucks blamed intense competition and a soft Chinese macro environment for the poor results in the country.

Overall revenue for the quarter declined by 3% to $9.1 billion, while adjusted earnings per share (EPS) plunged 24% to $0.80. This was well below the $9.4 billion in sales and $1.03 in adjusted EPS that analysts had expected.

In addition to its poor result, the company said that it would suspend its outlook for 2025. However, it did raise its quarterly dividend by 7% to $0.61 to demonstrate its confidence in its long-term growth.

Image source: Getty Images.

Turnaround plan

Starbucks' CEO said he would go into more details on the actions he is taking to help turn around the company on its upcoming earnings call. However, he did discuss parts of his plan. He noted that the Q4 results showed that Starbucks needs to fundamentally change its strategy. He said his "Back to Starbucks" plan will bring fundamental change.

Part of this is reestablishing Starbucks as a coffee company first and foremost. He said that through marketing and product innovation the company will remind everyone that it is a coffee company.

The next big focus will be on both its employees and customer service. He said the company must give baristas the time and equipment to best serve its customers and to be one of the best jobs in retail. He also said that Starbucks must provide the best customer experience every day, especially during peak morning hours. This includes improving staffing in its stores, simplifying things for baristas, and reworking its mobile ordering system so it doesn't "overwhelm the cafe experience." Niccol also wants to bring back that cafe experience, where Starbucks is once again offering the same amenities as a local coffee house.

Finally, Niccol said he wants to reintroduce Starbucks to the world, which includes fundamentally changing its marketing strategy. He said instead of focusing primarily on Starbucks Rewards customers that the company needs to talk to all of its customers. He added that Starbucks will look to fix its overly complex menu and its pricing structure.

No easy fix

Starbucks' shares have posted a huge rally since Niccol was named CEO, which comes on the back of his reputation of helping turn around Chipotle. But the truth of the matter is that turning around Starbucks is likely going to be a much taller task.

Meanwhile, some things Niccol hinted at to improve sales will likely hurt profits in the near term. In his remarks, he mentioned improving staffing and fixing its pricing architecture. Understaffing has been called out as an issue at the company, to the detriment of workers and the customer experience. While the former management team seemed intent on trying to fix this problem only with technology, Niccol appears to have opened the door to hiring more workers. I think this will be a good long-term move, but it is also going to add expenses and eat into profits initially.

Niccol also briefly mentioned fixing pricing. One of the theories on why Starbucks has struggled is that it started to price out its more occasional visitors. If the company has to lower pricing, it will obviously hurt gross margins and profits. That said, the company ran heavy promotions for Rewards Members in the quarter, but that did not drive traffic. Meanwhile, the company came out and said earlier this month that it would stop its promotions in order to help reposition the company as a premium brand. As such, what Niccol will look to do with pricing against this backdrop will be interesting.

Niccol also mentioned fixing Starbucks' overly complex menu. One of the beauties of the Chipotle model, where Niccol was previously CEO, was the company's simple menu with few ingredients. However, Starbucks has long been known for catering to customers who like to customize their drinks and order things off-menu. This adds time to the process for baristas, but it is also something that drives many people toward the brand. Any big changes to the company's menu could alienate many loyal customers, so it would have to walk a fine line in this regard.

At a forward price-to-earnings (P/E) ratio of about 22 based on 2025 analyst estimates, Starbucks is still trading at a valuation below where it has the past few years.

SBUX PE Ratio (Forward 1y) data by YCharts

That said, I think it is possible that Niccol may have to take some painful steps to help turn around the brand -- and this will reset earnings lower. While he has built up a lot of investor goodwill, investors might not be ready for such actions.

While I think the stock should be a solid long-term option, given the recent run-up and that 2025 will likely be a very transitional year, I wouldn't be a new money buyer of the stock right now.

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Geoffrey Seiler has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Chipotle Mexican Grill and Starbucks. The Motley Fool recommends the following options: short December 2024 $54 puts on Chipotle Mexican Grill. The Motley Fool has a disclosure policy.