Starbucks' Slow-Drip Recovery

In this podcast, Motley Fool analyst Anthony Schiavone and host Dylan Lewis discuss:

• The market's very upbeat reaction to Starbucks' fairly lackluster results.
• Brian Niccol's "Back to Starbucks" plan and the progress so far.
• Brad Jacobs' plans to run his proven acquisition playbook at QXO, and why Beacon Roofing Supply isn't eager to be bought up.

Is there a way to make clothing rentals work? If there is, Rent the Runway hasn't quite figured it out. But a quiet competitor might have. Fool analyst Nick Sciple joins host Mary Long to talk about a mall retailer with a subscription side hustle.

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A full transcript follows the video.

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This video was recorded on Jan. 29, 2025

Dylan Lewis: Brian Niccol gets to work at Starbucks. Motley Fool Money starts now. I'm Dylan Lewis, and I'm joined over the airwaves by Motley Fool Analyst, Anthony Schiavone. Anthony, thanks for joining me today.

Anthony Schiavone: Thanks for having me, Dylan.

Dylan Lewis: We've got a fresh cup of results at Starbucks and also a little bit of corporate intrigue with some poison pills and potential acquisition targets. We're going to kick off today talking Starbucks, though, and fresh results out from them. There seems to be so much excitement about the Brian Niccol era, but when we look at the actual numbers for the business, Anthony, it feels like the story is pretty similar to where it was a couple of quarters ago.

Anthony Schiavone: Dylan, no surprise here. It was a brutal quarter for Starbucks. Revenue of 9.4 billion was flat from the prior year. Global comparable store sales declined 4%, and that was largely driven by weak sales in the US. Operating margins, they contracted by about 380 basis points. Then on the bottom line, earnings per share fell about 22% for the previous year. As we're recording this, I think Starbucks is up about 6% today, so even though the results were not good, it was better than the market expected, so that's why the shares are higher today. I guess less bad news is good news for Starbucks in this case.

Dylan Lewis: When I've been trying to keep tabs on what's going on with Starbucks, I feel like a lot of the story has been customer expectations and habits and the pricing story a little bit with them. When we look at some of the key metrics, they are seeing foot traffic in their stores go down. They haven't been able to stave that off. They've been able to partially offset that with what they've been able to do in terms of average ticket and their prices. Do you see anything in the commentary from Niccol about getting people back into stores and reestablishing that habit for a lot of those folks that maybe weren't everyday shoppers, but were more infrequent shoppers?

Anthony Schiavone: Yeah. What Brian Niccol mentioned on the call was this back-to-Starbucks strategy, which I think is interesting. I must say it sounds a lot better than the triple shots with Two Pumps vision that the previous CEO put out. This back-to-Starbucks strategy that he outlined includes things like fewer discount-driven offers, which for a premium coffee chain, I think, makes sense. He also mentioned things like menu simplification, removing extra charge for non-dairy milk, reinstalling condiment bars, reintroducing ceramic mugs, handwritten notes on cups, and just making the store more inviting. I think that's a big part of the push that he's making. All those things are great, and I think it's definitely a step in the right direction, but as Jeff Bezos once said, customers are always going to want fast delivery. Obviously, Starbucks is a different business than Amazon, but I think the same logic applies here. I like that Niccol specifically called out improving staffing in certain stores to increase throughput, as well as investing in technology in order to sequence their mobile orders and then their in-store orders more effectively to reduce that wait time for customers. I think that's really going to be a big thing moving forward and something that I'll be watching.

Dylan Lewis: I don't think it's any revelation to our audience. Anyone who's walked into a Starbucks recently, the experience has been much more transactional. It has been much more mobile order oriented, and for a long time, that was a very large growth lever for them. The focus with that back-to-Starbucks campaign seems to be much more about that in-store experience and recreating the third place vibe that they were so well known for for such a long time.

Anthony Schiavone: He also mentioned in the call, Brian Niccol, about their broader marketing approach. I don't know if you watch a lot of TV, Dylan, but the new Starbucks commercials have really showed that back-to-Starbucks vibe, I guess, you could say, about making their stores more buddy. It gives off that feeling. I think it's definitely a push for them moving forward, and hopefully, it starts to come through because when you look at the results, the US consumer still wasn't necessarily coming back as much as management would have thought during the quarter. International sales were actually better than expected, but really that US core consumer is still not necessarily back to Starbucks yet.

Dylan Lewis: One of the things that's interesting with me looking at Starbucks is the conversation has been for the last several quarters that this company has a ton of things that it needs to fix. There was a ton of market excitement when Brian Niccol came on board. The metrics continue to bear out that there's a lot to fix. Shares are not very far off of all time highs that were set back in 2021. You look at a company on a valuation basis, we are starting to see that PE creep back up into the mid-30s. It's not exactly like people are getting a deal here as the company's figuring things out.

Anthony Schiavone: Exactly. When Brian Niccol was named CEO last August, I believe, since that time, Starbucks has added about $35 billion of market cap, which is absolutely enormous. I think the current market cap is somewhere around 110, 120 billion. To your point, things still aren't really that great, and there's a ton of room for improvement. I think the market is betting that Brian Niccol will be able to deliver on that back-to-Starbucks strategy and right the ship. I think that speaks a lot to Niccol because, honestly, outside of Howard Schultz, CEOs haven't really had a lot of success at Starbucks. I think it's going to be interesting to watch. Niccol is also bringing in some of his former colleagues at Taco Bell, too, to be in executive positions, so I think that's encouraging. But when I look at the valuation, business still definitely trades at a healthy premium. As a shareholder myself, I'm still in wait-and-see mode. On the earnings call, management pointed out that fiscal second quarter earnings are probably going to be even worse than this quarter, so I'd like to see some tangible improvements at Starbucks before I get excited about potentially adding to my position.

Dylan Lewis: It's interesting because in his time at Taco Bell, Brian Niccol was really known for moving that franchise over to a lot of menu innovation, a lot of exciting new products coming out that played into a lot of themes that consumers were excited about, the Doritos collaboration, things like that. We see Starbucks saying, "Hey, we're going to optimize our menu offerings, and we're going to slim things down and make things a little bit simpler in our stores." I think for folks that are looking for reasons to be excited about this business, one thing that jumped out to me was, they reiterated that goal of being able to double their storefront and seeing a massive opportunity there. We know that that type of thing is going to take a lot of time to actually build out near term, or I guess, maybe over the next year or so. Are there any particular things that you're really honing in on to see that they're making progress?

Anthony Schiavone: Well, I think going back to the US consumer comps, I think that's the most important part for me. I'm not too worried about international. I think that's eventually going to come a long time especially in China as those customers get more accustomed to coffee drinking and then move up the value chain. I'm not too worried about the international market right now, but really reengaging that core consumer that they've had for a long time that's left in the past a year or so. I think that's definitely the thing to watch for. Then store growth, too, like you mentioned, I think there's still a big opportunity to open up new stores. This company can still grow. I forget exactly how many stores they have now, but it's a lot, but I think there's still an opportunity in the future.

Dylan Lewis: I think of that Onion article, Starbucks opens inside the bathroom of a new Starbucks. Despite the fact that we are at that level of store saturation, they still see the opportunity, and I'm sure it's there. We'll just have to see exactly what that roadmap looks like for them over time.

Anthony Schiavone: Just to add one more point, about a year or two ago, I read an old article that was, I think, from 2005, that said McDonald's growth days are behind it. They weren't going to open up any new stores anymore because they're so saturated, but this year, they're opening more stores than they ever have. I think we can see a similar story play out with Starbucks.

Dylan Lewis: We've also got a little bit of boardroom intrigue going on this week. Brad Jacobs' QXO is looking at its first big buy, and it has its eyes on roofing supply company, Beacon. The problem, or maybe the thorn here, Anthony, is that Beacon does not want to be Brad Jacobs' dance partner. They are looking to put a poison pill in place to make this acquisition a little bit more difficult. I think just to kick us off here, do you want to give us a little bit of a rundown on Brad Jacobs' MO and what he's looking to do here with QXO?

Anthony Schiavone: Brad Jacobs is essentially a serial entrepreneur. He created seven billion-dollar companies. He literally wrote a book called How to Make a Few Billion Dollars, but essentially, what he does is he'll buy a company in a particular industry, usually a fragmented industry, and then he'll consolidate that industry. Then he'll add technology to improve the operations of the business. It's rinse and repeat. He's done that with a company called United Rentals, and then as well as XPO Logistics. Now he's trying to do the same thing and consolidate the building products distribution space, which is a massive space, has tailwinds because we have a shortage of homes in the United States. I think it's interesting that he's just rinse and repeat that same strategy throughout the years.

Dylan Lewis: As it stands right now, QXO is a SPAC by a slightly different name. He got QXO by putting about a billion dollars into SilverSun Technologies back in 2023. That was a software company at the time. He renamed it, focused it on building products, and then from that base, he is looking to run that playbook that you were talking about. When you take a look at Beacon, why do you think that this might be an interesting target for him?

Anthony Schiavone: It falls right into that building product space that he's targeting. This actually isn't the first time that QXO was rejected on the proverbial dance floor that you mentioned earlier. A French electrical supply company actually rejected a buyout offer from QXO last year. He wants to grow QXO to a $50 billion revenue business in 10 years, and he has raised a lot of capital. I think they have five billion dollars of cash on the balance sheet right now. Beacon, I think, was interesting because it's traded a decent valuation, and it seemed like an easy roll up for him, I think. But on the other side of that, I think a lot of these distribution businesses know the Brad Jacobs' playbook, and so I think that they believe they have some negotiating leverage over QXO because they know that he's trying to reach that $50 billion goal within 10 years. It's going to be interesting to see how that plays out.

Dylan Lewis: His track record, Brad Jacobs, is pretty darn solid. I think in his time as CEO of XPO, stock was about a seven or eight-bagger. He is still tied to that company. It has done very well over the last couple of years, as well. He's just not in the CEO seat anymore. Now that we are starting to see QXO begin making moves, and ideally, I think for Brad Jacobs, they have a couple acquired targets over the next year or two. Are you paying attention to this one? Is this a business or a stock that you're interested in?

Anthony Schiavone: I'm paying attention from a distance because the track record from Brad Jacobs is awesome, but this company, it's not a SPAC, but it's essentially just a pile of cash waiting to be invested. Jacobs, again, a great capital allocator, who's in charge of that cash, but I think I'd get more interested after they close their first deal. Plus, the market cap right now is higher than the cash on their balance sheet, so the market is betting that Jacobs will create value with that cash. I think it's going to be interesting, especially since when you think about Beacon and just the distribution business in general, it's a highly fragmented industry. The reason why that is is because these businesses are a bit counter-cyclical because they generate so much cash during market downturns, and they don't need to reinvest that money back into inventory. These businesses, they really go bankrupt, really go out of business. I wonder if the same attractive prices that became available to Jacobs in prior periods will come around this time, as well. I'm interested in this one, but watching from afar for now.

Dylan Lewis: You want to see the reality before you buy into the expectations?

Anthony Schiavone: Exactly.

Dylan Lewis: Anthony Schiavone, thanks for joining me today.

Anthony Schiavone: Thanks for having me.

Dylan Lewis: Coming up on the show, is there a way to make clothing rentals work? If there is, Rent the Runway hasn't quite figured it out yet, but a quiet competitor might have. Fool Analyst Nick Sciple joins Mary Long to talk about a mall retailer with a subscription side hustle.

Mary Long: Nick, Rent the Runway is a company that is fascinating and heartbreaking to me in part because I am a consumer of it. I love their subscription service. I love the clothing that they have. I've bought some of their items. I love the product, and I think that objectively, it is a pretty awesome idea. Going to a wedding, you can rent out a nice dress, sometimes for as low as 30 bucks, and it's an awesome, nice designer dress. They still use designer clothes at a really steep discount. Again, as a consumer, there is a lot to like there, but I deeply worry about it from a business perspective. It hit a high of $385.80 per share shortly after its IPO in 2021. Today, I'm wincing as I say this, it trades at closer to $8.50. Ow. What happened?

Nick Sciple: There is a lot of appeal to the product out there on the market. You don't get over 100,000 subscribers to a service without that, but I think delivering that appealing consumer service is difficult to do in a profitable way. You think about apparel retail by itself is a hard business. You need to accurately predict what customers' tastes are before they have them, and those can change very rapidly. On top, you have to have excellent inventory management. If you don't have enough product, then you're going to leave money on the table. If you have too much product, all of a sudden, you're writing down inventory and you're losing money. If you add on top the apparel rental business on top of that, you've got all those same inventory management issues, then you have to deal with things like subscriber churn. Lots of folks are going to add this service when they've got a wedding coming up and then wedding season is over, and maybe you're in cuffing season, you're turning off this service, and so you're having to make these predictions about product utilization.

Folks, they want to get these products cheap, but they also don't want something that's been used so much, it doesn't still look new and nice for folks that they're showing it off to. It's just a really difficult business to manage. You think about when Rent the Runway came public, was a nice setup for their business. We were coming out of the pandemic returning to things like weddings and big events, so that obviously juiced their subscriber numbers, but as the company has worked to narrow its losses, you're seeing subscribers come down in 2024 while this company continues to burn cash. It's an appealing service that hasn't become an appealing business.

Mary Long: In large part because of this Rent the Runway story, this divide between a beloved consumer product and a beloved stock pick has become a really interesting one to me. Exactly the questions you raised. I've been thinking a lot lately about whether it's actually possible to do the rental clothing business well. That question brought me to Urban Outfitters, which owns physical stores and digital brands, like its namesake, Urban Outfitters, but also Free People and Anthropologie, they have a rental clothing business of their own, it's called Nuuly, and it makes up about a little less than 7% of net sales through the first nine months of 2024. That percentage has grown over recent years from 1.1% in 2001. What are we seeing here? Is this subscription service a genuine growth opportunity for Urban Outfitters?

Nick Sciple: Well, management certainly thinks so. You compare, I said earlier, about 135,000 subscribers for Rent the Runway. Nuuly is already much bigger. Over 300,000 subscribers, is the largest rental platform in the US. Long-term, though, management thinks they can get to millions of subscribers for the service, and they're certainly continuing to grow really fast. They put up 81% subscriber growth in 2023 and they just released earlier in January, subscriber numbers through the first 11 months of 2024, another 51% growth. This isn't just taking share from Rent the Runway, other rental platforms, they're growing the market. More than two thirds of Nuuly subscribers report never having rented clothing prior to coming on to the platform. I think they're maybe picking up the torch that Rent the Runway dropped.

Mary Long: You and I started talking about Urban Outfitters a couple weeks ago, and you said then that you wished Urban would spin off the Nuuly subscription into its own separate business. Why is that?

Nick Sciple: Well, just like a lot of these businesses that you see buried inside a larger one, you're curious, hey, what would the stand-alone profits of this business be without all the rest of the accouterments around? Also, what is the multiple the market would give the stock? Obviously, it's been a tough run for Rent the Runway, but they're not showing subscriber growth. They're not really showing net profits. However, Nuuly is doing that. I'd be interested to see what multiple you'd get on Nuuly as an independent company. That stead, strategically, makes a lot of sense why you'd want to keep Nuuly as part of the greater URBN umbrella.

This is a business that's going to have to burn cash to grow. You can't increase subscribers 80% or 50% year-over-year and keep up with the inventory, your subscribers are going to expect without continuing to spend money, and the public market might say, "Hey, we'd like to see a little bit more return and less of that growth." But inside a company like URBN, you can spend cash to continue to grow the business, management has said company could be cash flow positive if it stopped investing in inventory, maybe we'll talk about that later. Maybe they can never stop investing in inventory, but if you're in the public market, the ability to invest in that growth, I think, would be shackled a little bit because of the expectation of return.

Mary Long: It's pretty clear that Nuuly is doing a much better job at the subscription business than Rent the Runway. You've already pointed out a few of those metrics. Nuuly had its first full year of operating profit in 2024. Rent the Runway still has a negative operating profit, and about half the subscribers, as you've mentioned that Nuuly does. What is it that Nuuly has gotten or understands about this business that Rent the Runway can't seem to understand or execute on?

Nick Sciple: I think a lot of it is just that retail DNA that Nuuly brings to the business with its other family of brands, it has that ability to predict demand in the market in a way that maybe Rent the Runway hadn't had to develop the same abilities. I think there's just a little bit different DNA to the company, a little bit different approach to the business that's led to that leg-up. But it's really just my intuition. Could just be the marketing you get from being able to cross-sell across these other brands as well. For whatever reason, they found better product market fit than Rent the Runway and they seem to be the market leader now.

Mary Long: Let's move over to that other side of URBN's business, the physical stores piece. It's that namesake Urban Outfitters brand that is the one that seems to be struggling the most. Holiday sales in 2024 were down 4%, 2023, 2022, both saw decreases in comparable sales as well. Other retailers, namely Abercrombie & Fitch, have executed really impressive turnarounds and become Wall Street darlings in recent years. What does Urban, the store, have to do to execute, like an Abercrombie & Fitch style turnaround?

Nick Sciple: I think it's just good old fashioned retail and what we were talking about earlier. I think the brand has struggled the past few years with those steadily declining comp sales, increased markdowns. I think it's really just not having product that was resonating with the customer. Management's also talked about a perception of the customer that their product was expensive. At the same time, leadership was inflexed. They were sharing leadership with another unit of the company, lots of changeover. I think that lack of focus maybe was what led to some of those apparel-mix issues. I think the brand has started to take steps to begin a turnaround here in 2024. They hired Shea Jensen to be the president of Urban Outfitters North America, so now they have a dedicated leader, and she's been focused on repositioning the brand, which Abercrombie & Fitch also did. They're not going for as big of a different customer.

Abercrombie really aged up significantly, but repositioning the brand, adding new categories like athletes. The brand is also looking to get smaller. If you look over the next few years, 50% of its leases in North America will expire, and that'll let them get out of some of these larger stores that just haven't been profitable. For the business and they say they want to refocus around smaller stores in ironically, more suburban areas, less big city centers for Urban Outfitters. It is early days. As you said, comp stores fell 4% in the holiday period, but that's better than the double-digit declines we were seeing in past years. If you drill even deeper, the brand did see a little bit of an increase in full-price sales, so more product being sold without a markdown and traffic to its website, which you could say is early signs that the brand is starting to turn around and not be the drag it has been on the overall business.

Mary Long: It's not just Urban Outfitters that falls under this URBN umbrella. Urban Outfitters accounts for about 25% of the company's net sales. Anthropologie is responsible for 43% of net sales and has 16 quarters of growth in comparable sales. Free People, another brand contributes 21% to net sales and is also growing. We focus just now on the struggling Urban Outfitters' business. Why is that having such an outsized effect on URBN overall?

Nick Sciple: If you look at the stock, it's not holding it back. We're close to all time highs here, but I think it's certainly where there's gains that can be made, where the business really isn't humming, because if you look at the other sub-brands, they really are crushing it. Anthropologie, you mentioned the 16 straight quarters of comp sales growth, if you zoom out over that same period since 2021, their customer base up 30%, sales per customer up 20%. Same store sales up almost 20% and four-wall profitability of those stores up over 900 basis points, so really remarkable results for a retailer that's 30 years old here today. Free People also putting up double-digit or very close to double-digit comp sales growth the past few years. If you look at its FP movement brand, its athleisure sub-brand really has been a standout for the company. Sales have grown at a 39% compound annual growth rate the past five years, and there's more to come. I think it just did a 25% comp sales number here in the most recent quarter. Today, FP Movement has 63 stand-alone stores in addition to some store in stores inside the Free People brand, but long-term management, I think this can get to 300 stand-alone stores and over a billion dollars in annual sales. If it does, then you see FP Movement punching in the same area as Urban Outfitters and as the overall Free People brand.

Mary Long: I was surprised to learn when looking more deeply at this company that it's actually a family business, apart from that just being an interesting fun fact to keep in your back pocket. Is there anything within leadership or about leadership that you think is important for investors, potential investors to be aware of?

Nick Sciple: Family business. The Hayne family has controlled the business since it was founded today, still controls over 25% of the shares outstanding. Dick Hayne, co-founder remains the chairman and CEO has been with the company since 1970. His wife has been with the company since 1982, and she's the chief creative officer of the business. The leader of Nuuly is Dave Hayne, which is their son. He's also the chief technology officer of the business, so you certainly need to have faith in the Hayne family to invest in this business, but I think it also maybe says something about the commitment they might have to the Nuuly brand. The son of the founder is running this and has run it from Day 1. You've got a lot more investment in maybe Rental than maybe you would have seen other places, but if you're concerned about overly involved family influence in your business, this might be a company to stay away from. It's not the type of thing that bothers me. I think folks who are stewards of their businesses tend to produce good results for shareholders.

Mary Long: It's not the kind of thing that bothers me either. In fact, URBN is a stock that I'll admit is on my watch list. I really love the subscription idea. I see potential for its already thriving stores to continue to do that, for it to turn around the more struggling brands. It's trading at a price to sales ratio of about one. The increase of its stock price in recent years is pretty in line with its increasing earnings and how they've trended upwards. I also feel like no one is talking about this stock. I'm not an analyst. Nick Sciple, that's not my job, but you are. As we close out, what do you say? Am I smart to have this on my watch list? How do you read this?

Nick Sciple: Looking at the stock, I do think it is pretty interesting here, and I'm someone who has a little bit of skepticism about apparel retail because of the difficulties we let off talking about, but the stock has doubled the past five years. Now, the previous 10 years before that, it went nowhere, which, Tim, maybe tells you about the risk in apparel retail. That said, the appreciation of the stock, as you mentioned, has been mostly business performance, earnings, trading multiples are about in line with where the stock is traded over the last decade. This hasn't been multiple expansion. Sending the stock higher. I think if you look at the sub-brands, those areas where there's growth, I'm excited about what is going on at FP Movement and at Nuuly. I'm optimistic about the changes at Urban Outfitters and whether it can stop the decline. Maybe going back to long-term, I do question, what is the point at which Nuuly stops burning cash and becomes sustainably cash generative? Obviously, as you're growing the business, you need to continue to put cash in to support the growth in subscribers, but also over time, you're always going to have to continue to turn over your inventory as fashion tastes change. I do think they're doing some interesting things selling thrift Anthropologie stuff on their website that's run through the Nuuly brand.

There's interesting ways that they can manage inventory that I think gives them advantages over other folks in the market, but I think if Nuuly can really prove itself, I think there's really a significant opportunity for growth in the business. As I said, I don't think the multiple today really reflects those growth opportunities. They reflect what the business was like in the 2010s before FP movement or Nuuly really were significant parts of the business at all. I think if you're optimistic about those areas and potential for growth, potential for Nuuly to drive sustainable free cash flow over the long term, I do think it can make sense to start a position in URBN here and buy and hold over the long-term to see if they execute. Certainly, a fun business to follow. I know my wife's a fan of the Nuuly subscription, so we'll keep our relationship with the company, at least in that way.

Mary Long: Much, though I love my Rent the Runway subscription. I might have to switch over to Nuuly to conduct market research. That's what we'll call it. It's for work. Nick Sciple, thanks for joining us here and giving us some more intel on this very fascinating company.

Nick Sciple: Thanks, Mary.

Dylan Lewis: As always, people on the program may have interest in the stocks they talk about and the Motley Fool may have formal recommendations for or against, so don't buy or sell anything based solely on what you hear. All personal finance content follows Motley Fool editorial standards. It's not approved by advertisers. Motley Fool only picks products it personally recommend to friends like you. I'm Dylan Lewis. We'll catch you guys tomorrow.

Anthony Schiavone has positions in Starbucks. Dylan Lewis has no position in any of the stocks mentioned. Mary Long has no position in any of the stocks mentioned. Nick Sciple has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Starbucks. The Motley Fool has a disclosure policy.