Starbucks (SBUX) is trading lower today (-5%) after reporting Q1 (Dec) results last night. Non-GAAP EPS came in at $0.58, when you back out a $0.07 benefit from tax law changes. Revenue rose 5.9% year/year to $6.07 bln. EPS came in slightly above market expectations but the revenue was light. Non-GAAP operating margin came in at 19.2%, which was a 80 bp YoY decline.
In terms of same store comps, which is a key metric for SBUX, global comps increased +2%, driven by a +2% increase in average ticket. China, once again, was SBUX's fastest growing market in Q1 with +6% comp growth, driven entirely by increased transactions and +30% revenue growth. Customer response to its Shanghai Roastery has been extraordinary, and the Roastery is already performing well above expectation.
In terms of its US business, comps were up a more modest +2% while overall revenue growth was +6%. Continued strength in throughput at peak times and strong digital performance were noteworthy highlights in the quarter. However, its overall US operating performance fell short of expectations.
So what happened with its US business? Through the first half of the quarter, its US comps were +3% with strong performance at peak, more than offsetting some softness in the afternoon. But as SBUX launched its holiday program in mid-November, the company saw a slowdown in transaction costs, bringing total comps for the back half of the quarter to roughly +1% with transaction comps slightly negative. These developments contributed to some margin compression in the US segment.
The decline in transaction comps was primarily driven by two factors: First, while traditionally contributing to DecQ comp growth, SBUX's limited time holiday beverages, holiday gift cards and holiday merchandise underperformed expectations. Holiday LTOs (limited time offers) and merchandise did not resonate with customers as planned. Second, the challenge which has been discussed over the past several quarters involving softness in business by occasional, non-Starbucks Rewards customers. This is a challenge likely exacerbated by the traditional changes in customer routines and traffic patterns during the holidays. Another factor was negative mall store comp performance. Mall locations were several points below non-mall locations. Mall stores comprise about 6% of its US locations.
SBUX says it has a clear understanding of the issue and how to fix it, just as it did with throughput at peak. The strength of its core customers, the performance of its business through the morning and lunch and upcoming food, beverage and digital innovation gives SBUX confidence that it will be successful in doing so.
SBUX is focused on elevating the Starbucks experience in the afternoon daypart, as store partners sharpen operational focus and tune staffing and scheduling, simplification processes and leverage improved routines and lean techniques. The chain is also driving innovation in food and leverage. Its Mercato fresh food menu is continuing to perform well in Seattle and Chicago, the two markets where it launched last year. SBUX is planning to deploy Mercato in at least six new markets in FY18.
Also, SBUX recently launched Blonde Espresso roast. This is the first time the chain has offered a second espresso roast in its stores. SBUX believes this roast is appealing to a broad audience seeking a lighter, sweeter, espresso experience. Looking ahead, SBUX sees a big opportunity to leverage its core beverage platforms, particularly in iced coffee, tea, cold brew and draft beverages, all of which skew toward the afternoon.
In response to strong customer demand, SBUX is accelerating the rollout of Nitro Cold Brew from 1,300 stores currently to 2,300 stores in the US by the end of the year. Nitro also provides the foundation for a broader platform of draft beverages that expand beyond coffee to include alternative milks and tea-based nitro-infused beverages. Also, its plant-based beverage platform continues to expand, leveraging almond, coconut, and soy milk alternatives. The hope is all of these drinks will help improve the afternoon daypart.
In sum, SBUX is trading lower on this earnings report. While China keeps booming, the US business had areas of softness, especially some weakness in the afternoon daypart and in its mall-based locations. The good news is that management sounds confident it can fix these issues just as it did when it had trouble serving customers at peak times.