Starbucks Goes Back to Basics

In this podcast, Motley Fool analyst Kirsten Guerra and host Mary Long discuss:

• Starbucks‘ bitter earnings; CEO Brian Niccols’ barista-focused turnaround plan.
• Surprising beats from an old automaker.

Then, Mary and Motley Fool analyst Tim Beyers discuss Instacart‘s “Caper Cart” technology and advertising business.

To catch full episodes of all The Motley Fool’s free podcasts, check out our podcast center. To get started investing, check out our beginner’s guide to investing in stocks. A full transcript follows the video.

This video was recorded on Oct. 23, 2024.

Mary Long: You get a surprise, and you get a surprise. Everybody gets a surprise. You’re listening to Motley Fool Money. I’m Mary Long joined today by Kirsten Guerra. Kirsten thanks for joining us on the show this morning.

Thanks for having me here on this surprising day.

Mary Long: Surprising day. Having you was not a surprise, but perhaps some of the topics that we’re covering today do come as a bit of a surprise. One of those surprises is that Starbucks decided to gift us with their results a little more than a week early. They dropped preliminary results yesterday. The full results are due October 30th. That will be freshly mended CEO Brian Niccol’s first call with analysts in this new role. Before we dive into what we’re seeing here, maybe give us a primer on why companies choose to beat themselves to the punch when delivering bad news in the first place.

Kirsten Guerra: I think it can be a signal of goodwill toward investors, generally, especially if the results are going to be considerably off of expectations. It’s the company saying, like, hey, we don’t want you to be shocked on earnings day, so we’ll shock you today instead or just a little bit of the shock. I guess, really, in this case, I think it’s just new CEO, Brian Niccol, distancing himself from the upcoming results, acknowledging the results right now is like saying, hey, the momentum for these less than stellar results is already in the works. It’s not because I made my first few changes as CEO and made everything a little worse. It was already coming to fruition. That would be my best guess in this case.

Mary Long: Key takeaways from these early results are not awesome, as perhaps that early drop indicates, revenues down, earnings per share is down, same store sales are down in, North America, in China, globally, foot traffics down, average tickets down. That’s a lot of downs. The company also suspended its outlook, looking ahead to the coming fiscal year. You’ve already mentioned this Kirsten, Niccol came in, and so he only came in in September, and so a lot of these changes are due to the previous management. If we’re not grading Niccol on these results, what is it fair to grade him on right now?

Kirsten Guerra: Yeah. Now is a very squishy time to be evaluating Niccol. It’s how you measure anyone’s success in a new role, I think. Niccol is a very process oriented and systems guy, a broad-scale strategic thinker. The first part of that is absorbing a ton of detail at the unit level, back to basics, what makes a single store tick? What can be better, and then scaling that to more than 15,000 locations. So far, I think Niccol is doing exactly that. He says he’s spending most of his time directly in these stores, learning from partners and customers and their support center and teams. The other big thing, of course, that we can look at now is just general communication. We know that there’s a ton of expectation for this guy. We saw that with the 20+% jump in stock price just at the announcement that he would be CEO. I think shareholders are really expecting to hear very clear, detailed plans from him. For now, his first prepared remarks really seem very focused and motivating, and that ability to motivate is something we need to continue to see. It’s important because it’s more than just shareholders. He’s also about to motivate about 350,000 or so employees to come along with him on this turnaround.

Mary Long: We’ll get more into the outlines, the beginnings of this turnaround that Niccol outlined in a video that accompanied these preliminary results. But for now, one of the bright spots in a bunch of negative is perhaps that Niccol announced Starbucks would be raising its quarterly dividend. That dividend will go from $0.57-$0.61. What do you make of this? Do you see this as a genuine indication of management’s long term faith in the company, or is this more lip service?

Kirsten Guerra: I do think it’s an indicator of long term faith in the company. More than that, even, I would say it’s just continuing their commitment to shareholders. Starbucks has paid a dividend every year for the last 20 or so years, and it’s raised that dividend every year, something like the last 13 years. With Niccol coming in, no one wants to be the leader that breaks that streak unless you have to. Yeah, it’s definitely showing that they’re committed to it. At the same time, though, Starbuck’s payout ratio is upwards of 60%, and the payout ratio is essentially of all the income a company brings in, how much of it is immediately spoken for by going to pay that dividend, so 60% is pretty high, a little unsustainably high. A healthier target would maybe be in the range of like 30-50%. A bit below, 60 is fine. It’s not dire, and Starbuck’s payout ratio has been higher before. But, ideally, they need to keep increasing the net income part of that equation to give themselves a little more padding, so that they can maintain this focus on consistently raising that dividend. I know, simple, just make more money. Make more net income. Come on Brian.

Mary Long: As if we could just snap our fingers and make it half it.

Kirsten Guerra: Exactly.

Mary Long: Part of the reason for Starbucks is trouble is that it over complicated its menu. It leaned more into sugary drinks and got away from the coffee that it was known for. It leaned really hard into digital orders and lost this community third place esque feel that it was known for years ago. The previous CEO Laxman Narasimhan knew this. He saw this and dubbed his own reinvention plan, the triple shot reinvention strategy. Now that Narasimhan is out, that plans out, but Niccol is in with a new plan that he revealed to us today, that plan is called back to Starbucks. Is Backwards the the right way forward for this company?

Kirsten Guerra: Potentially. Yeah, it’s just a classic back to fundamentals where you identify them. What were the most crucial contributors that helped Starbucks scale to such a brand today and really finding a better balance ideally for customer retention and brand loyalty, pricing power, all of that in connection to efficiency. We obviously still want efficiency here, but there is a degree to which you can take it too far. I think they need to refocus on their original mission, which also tends to motivate the workforce behind them to refocus as well. For example, you mentioned, one of the things that he’s really focused on, Niccol is really focused on now is that the company has been too focused on their rewards members. That naturally is because loyalty programs are a huge growth driver for any consumer business.

It’s probably easy to fall into the trap of just really focusing on that. But ideally, you should just market to everyone, and let the rewards program work its own magic in the background, at least Niccol thinks so. Then the other big thing for him is this overly complex menu. He’s coming from Chipotle, where individual ingredients are actually quite few, and the magic, I guess, is in the customization. I wish I had an interesting number to compare the depth of Starbucks’s menu to Chipotle’s. But honestly, I think if you just walk into either store, you can feel it. Starbucks has way too much going on. Most likely if Niccol pairs that back, Starbucks will probably lose some customers. Someone’s favorite drink will be cut, I hope it’s not mine, but they will lose some customers on that. It’s just Niccol and his team, will have weigh that against the efficiencies earned from the simpler inventory, the reduced labor, the quicker make times, and the greater throughput. It’s really just back to basics to find the right balance again.

Mary Long: What is your favorite Starbucks drink, Kirsten?

Kirsten Guerra: Mary, I don’t know. I would have to check the app. I’m an app order. I will stumble on what my order is if I walk up to a barista. Please don’t ask me.

Mary Long: This reveals just how complicated the menu is.

Kirsten Guerra: It is.

Mary Long: If you don’t even know what your favorite order is if you’re like, I don’t know what the app does, I could tell you what I could sue it on a regular basis.

Kirsten Guerra: I know that it has cinnamon in it, and I know that it has oat milk. Yeah.

Mary Long: Fair enough. I think there’s triple digits of combinations that we could make from that considering how many different options are at Starbucks. One of the things that stuck out to me in this turnaround plan is this real emphasis on baristas and quality and people. Niccol talked a lot in this six minute video that dropped alongside these results. In giving in store employees, AKA, green apron partners, the time they need to do their job well. He talked a lot about career development and offering meaningful growth opportunities for those employees. He seems to believe that doing this by focusing on the people that make Starbucks a successful company is a form of quality assurance when it comes to the beverages.

He said this, we are reorienting all our work to ensure we deliver a high-quality hand-crafted beverage, prepared quickly and with care, and this is the part that, in my notes, I boil italicized underline and handed directly to the customer by our barista. This seems to me like it’s a pivot not just from the Starbucks that we’ve seen in more recent years of the more dystopian empty space that’s totally focused on fulfilling digital orders. But it also feels like a pivot away from this general trend that we’re seeing across industries where the focus is on AI efficiency, etc. This, in contrast, feels like very warm and fuzzy, people are the key. I am all for that, but at the same time, I doubt that in person coffee handoffs is going to be the metric of success that’s revealed at Starbucks actual earnings drop next week. With that in mind, how can investors measure the success of squishier success metrics that Niccol is pointing to here?

Kirsten Guerra: I agree with you. I don’t think we’ll see that metric.

Mary Long: Same.

Kirsten Guerra: Like I’ve said, it’s really a balance. Most companies are moving toward efficiency. What we’ve seen here is a company that has over indexed to efficiency, so we’re pulling back a little bit. I think ultimately, it’s a very delicate balance. I think what we watch, honestly, is just the classic revenue is the main thing, regardless of which direction a company is moving toward, whether it’s more efficiency or pulling back a little bit and looking for more quality for a higher customer satisfaction. If you strike that balance right, it should show up first and foremost, just in revenue. If revenue slows or is flat or even worse down, they’ve probably got that formula wrong and need to rebalance. I don’t know. I went this morning and my drink had like a full inch and a half of hair at the top, the drink that I can’t even describe to you.

It’s happened the last few times I’ve gone, and that is frustrating. It might be a localized issue, but it’s certainly an issue. I think it’s fair to say, at least from my anecdotal perspective, efficiency has certainly gone too far here, if they’re trying to turn out all these orders and losing that level of quality, and so I would remove myself as a customer if this were to continue. That’s a loss of revenue. If they can fix it, though, they earn my revenue back. Revenue is just the first and foremost thing I would be watching here.

Mary Long: We promised listeners a day full of surprises, so let’s move on to our next surprise. This one of the more positive variety, General Motors ended yesterday having had its best day on the market since March 2020, up about 10% after hours, quarterly revenue up year over year, earnings per share, following a similar trend per their latest earnings. Kirsten, when we were talking this morning about potential topics to discuss, you said that GM surprised investors. What about this was surprising?

Kirsten Guerra: Well, it’s an old legacy mass-market US automaker. Big beats generally aren’t expected. Last year, on this very show, I pitched GM in a March madness bracket, and everybody laughed at me. I lost out to Tim, who pitched monday.com, and where are those two companies now, Mary? GM is up around 62% beating the S&P 500. Monday, is up about 110%. Anyway, we all win. Go back to your question, one of the more surprising pieces of news I would point out in these results was in China. GM sales in China grew 14% sequentially from Q2, and that’s not huge, but it’s a big directional change for a market that’s just been draining GM for years. In fact, when I valued GM around the time of the pitch that I mentioned, I projected China as a continuing slow decline for GM. I just factored it out, and so naturally, any news to the contrary is going to inject a little hope for restabilizing that market. Add a corresponding little boost to the share price.

Mary Long: Kirsten, what I’m hearing is, this was a surprise for everyone else, but not for you. Don’t bet against Kirsten.

Kirsten Guerra: I told you.

Mary Long: Perhaps another part of the surprise is that the past year has not been nearly as rosy for other automakers. GM stock is up 80% in the past year while shares of Ford, Stellantis, and Volkswagen all in the red. What is GM getting right that other car companies are missing right now?

Kirsten Guerra: The big macro does apply to all of them. All of these automakers are in a tough spot with the sentiment volatility toward DVs and the demand softness that has affected all of these companies. But one bright spot for GM is that they’ve held steady on their pricing. They’ve offered fewer incentives than competitors, yet sales have tracked right along with the broader market. They are demonstrating some clear albeit minor pricing power there. They’re also really focused on some things that consumers may not directly care about, things like securing their own battery supply chains for security reasons into the future. But also some things that consumers will definitely care about when making their next vehicle choices, things like a cattle partnership, that’s a Chinese battery a power supply company, partnering with them for a battery that can deliver 200 kilometers of range on a five minute charge, and that’s not expected until late 2025, and as withal battery timelines could actually push a bit further out. But if fulfilled anywhere near that timeline, that’s definitely one of the most attractive options on the market to ease range anxiety, so that’s a big focus, of course.

Finally, I would just say, some decent capital allocation here just in the last 12 months versus the full year 2023. GM has reduced its total share account by almost 14%. It’s made some big repurchases indicating it believes in its own stock, as has, by the way, the CFO at GM Paul Jacobson. Multiple times in 2023 and 2024, he put down more than a million dollars of his own money to buy more shares. If that’s not a sign of confidence, I don’t know what is.

Mary Long: Kirsten, I think the theme in all these stories that I’m hearing from you today is just make more money. What? Like, it’s hard?

Kirsten Guerra: Sell more coffee, sell more cars. I think I should be a CEO, and you, as well, you get it. More money.

Mary Long: More money. Kirsten, thanks as always for joining us today. Pleasure talking to you.

Kirsten Guerra: Thanks for having me, Mary.

Mary Long: Next great ad campaign might be coming to you from your grocery cart. Up next, Tim Beyers joins me for a look at an underappreciated side of Instacart’s business.

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Mary Long: Our TVs are smart, our cars are smart. Now, our grocery carts are getting some brain power as well. Instacart acquired Caper AI, a leader in so called Smart cart technology back in 2021. CEO Fidji Simo has since called Caper Carts the centerpiece of Instacarts mission to help grocery partners “deliver the best omnichannel experience” Tim, when I think of the grocery store, I think of it as a single channel, multi aisle, but single channel experience. What does an omnichannel experience look like at the grocery store?

Tim Beyers: Yeah. It’s an interesting one, Mary, but let’s start with what omnichannel means. It means engaging with customers across several different channels. In this case, channels are things like in store, in app. Out in the world or just generally online. Any place you are, think of a channel as a place of where you are engaging with a product or service. Caper carts are interesting and that they automate the shopping experience to a degree. It’s like anything else. You walk into a grocery store, and you have this funky cart that has what looks like an iPad on it, and it’s thick. It’s has trying to look a little bit hip, and it’s got this. It’s outfitted, and so you start shopping the way you always would. What happens is the cart is connected, essentially to everything inside the store, so you pick something off the shelf, drop it in the cart, and the tally of your grocery bill appears on the screen. It just knows automatically what you have put in your card, how much it costs, and it keeps a running tally for you. If you think about all the data, it is collecting as you shop, that’s pretty mind blowing. What does that mean? Like when you are, and this is where the omnichannel piece comes in, you put something into the cart, and you signal intent, say, about a brand, especially if you’ve bought that brand more than once.

Maybe you linger in an aisle, and that might signal there’s an opportunity to maybe change your mind on the brand you ultimately buy, like, if you got a better deal on a competing product, for example. All of this stuff is super interesting, and it can be used to make the shopping experience more interactive across channels. Let’s say one thing this happens. Take that example, Mary, let’s say you’re lingering in the aisle where it’s for hair care, sundries, like, toothpaste. You’re lingering in that aisle, and ultimately, you put a three pack of Colgate toothpaste into your smart card. That’s data that Instacart has, that a brand, like if Crest, I don’t remember what is the holding company for the Crest brand, but whoever that is, let’s assume it’s Procter & Gamble. I’m just stuff up here. I think it’s probably P&G, so then P&G has a deal with Instacart, and Instacart shows that data to P&G, so that now, maybe you get an email. Or maybe you get as part of a mailer you’re getting crest. They start showing up. Maybe you have different apps that you use for clipping coupons and deals for Crest start showing up. That is the byproduct of data that is used to engage you in an omnichannel way. You took data from one channel, and you made it useful across lots of channels. Does that make sense?

Mary Long: It does make sense. I think that this is really fascinating and something that perhaps goes under noticed when people think of Instacart, because as a consumer, I am most familiar with Instacart as a grocery delivery app.

Tim Beyers: Right.

Mary Long: But what you’re describing is an entirely different segment. It’s really more advertising. When you think about Instacart as a business, talk to us a bit about how you view that advertising piece playing into Instacart moving forward.

Tim Beyers: Advertising I think of it as the glue that makes the Instacart experience a little bit stickier because you can create multiple wins with partners. Brands that want to sell more of their products will advertise on Instacart. The way to think about advertising inside of Instacart. Let me take a step back for a second. Instacart is a two sided marketplace, so what you’re doing is you have demand, so shoppers who want goods. That’s demand. Then you have supply. You have grocery chains and other retailers that supply grocery, sundries, all of this stuff. Instacart sits in the middle. They have a platform advantage. The burden on them is to provide value to everybody that is connected to them on that platform. Both the consumers, who want grocery delivery or grocery pickup, and the grocers who are selling products that are fulfilled through Instacart. Everybody’s got to get some value.

Another participant in that platform are brands. Like Crest, it’s like, hey, we want to sell more Crest. If we want to sell more Crest, we need to know how it’s selling, where it’s selling, under what conditions. Instacart is a particularly I would say, impressive partner that has that data that just makes it stickier. They will, for example, and classically, when you’re talking about grocery selling, you know that I-line, you walk down the aisle. We’ve all done this, and you have the I-line. That is the most important space in the grocery store in any aisle. Those brands pay a premium for that, and they usually pay it to the grocery store. In Instacart, the I-line shelf space is the offer that pops up in the app. Crest available for, and it’ll have something like 199 a pound/ through 179 a pound. Now that’s an offer that is available there inside of Instacart. It’s shelf space. This advertising business is really important. It’s important for brands. It’s important for retailers, and the more that shoppers use those offers, engage with that shelf space, the more signals they send about products and about intent, about who they are as a shopper. This ad business, or maybe another way to put it, this data business is really huge. It says a lot about how a customer will engage with Instacart, and therefore, the retailer that Instacart is fulfilling for.

Mary Long: Instacart has been growing revenue, but the past two years have seen big spikes in expenses, particularly in regards to R&D? This is also a company that is generating cash, but it’s not yet profitable on an operating business. Instacart spends a lot on stock based comp. That’s just a scattering of notes right there. But I want to focus in on this expenses piece because I assume a lot of those research and development costs are attributed to the smart cart stuff that we’ve been talking about so far. What returns do you expect to see from that kind of spending?

Tim Beyers: Well, to be fair, a lot of that dramatic increase is due to equity granted to employees and investors before the IPO. Like, this is still a fairly recent IPO. Part of the deal that Instacart made with investors and employees is that when the company went public, that would be an equity cliff, and they would just invest just a mountain of stock, and they did. They had to realize huge amounts of stock based compensation expense upon going public. It looks terrible right now. It really looks bad, but it’s really not because this is a one time event. There’s no question there’s going to be more equity grants for Instacart employees. That is to be expected.

But it’s not nearly going to be what it has been now that the company is public and its obligation to invest long term equity has been satisfied. But to your question, Instacart is absolutely going to keep investing in R&D in order to build out the Caper carts business, upgrade the app, improve shopper efficiency. Again, this is a two sided marketplace where a lot of people are depending on the company to make more money at reasonable margins, and there’s simply no way to do that without continuing to innovate. I’ll give you a quick example here. Instacart has built out a machine learning capability. This is not AI, but it’s a form of AI that helps to predict when items are available in store. this is really important because one of their constituencies.

Again, you got groceries, you got grocers, or suppliers, you have those customers. Then you also have the fulfillment team, which are the shoppers, the shoppers who show up, and they depend on Instacart to make profits. This machine learning capability that’s looking for and looking to predict whether or not a product is available in real time, and then taking feedback from shoppers who go in to fulfill an order in order to do better predictions consistently, that’s really important for the shoppers, because the one thing a shopper does not want to do is have a list and order from say you, and then 60% of the order can only be filled because you thought that all of these things were available. In fact, they weren’t available.

Instacart has to be better at predicting if something is going to be available to help its shoppers make money and to make you a satisfied customer. This is all super important, like, how they collect data, when they collect data, where they get it from, how they process it to make everybody more interested in Instacart. Everybody has to make more money with Instacart. Like I said, it’s a significant burden. But if they fulfill it, and increasingly, they have been fulfilling it, it makes everybody more money, and it makes everybody more committed to Instacart, and that is important.

Mary Long: Tim Beyers, as always, it is a pleasure talking with you. Thanks so much for chatting with me today.

Tim Beyers: Thanks, Mary.

Mary Long: 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 stocks based solely on what you hear. I’m Mary Long. Thanks for listening. We’ll see you tomorrow.