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Starbucks typically closes about 100 company-operated stores each year across Canada and the U.S., chief executive officer Kevin Johnson said in an open letter last year, 'primarily due to lease expirations, trade-area shifts and other market conditions.'HENRY NICHOLLS/Reuters

Canadian investors who have watched some of their neighbourhood Starbucks stores shutter in recent months might understandably wonder if the world’s largest coffee retailer is losing its buzz.

The Seattle-based specialty coffee chain said last fall it would close about 300 of its stores in Canada and 500 in the United States – an additional 100 in each country than previously announced months earlier – as part of an accelerated “trade area transformation initiative” amid the pandemic. Starbucks said it was shifting toward more “convenience-led formats” including drive-throughs, pickup and delivery.

That left the company with 963 corporate stores and 441 licensed locations in Canada as of its third quarter ended June 27, compared with 1,175 corporate stores as of Sept. 29, 2019, when it had 423 licensed stores.

Starbucks typically closes about 100 company-operated stores each year across Canada and the U.S., chief executive officer Kevin Johnson said in an open letter last year, “primarily due to lease expirations, trade-area shifts and other market conditions.”

Although the recent store shutdowns were well beyond typical levels, Starbucks executives and analysts that follow the company say they’re part of a healthy renewal of store formats to meet current needs. In the most recent investor call, Mr. Johnson said the fast-tracked trade area transformation program has helped the company offset higher costs and “puts us back on the front foot for net new store growth in North America.”

Restaurant chains have a “natural amount of turnover” because of changing demographics and consumer traffic patterns, according to Morningstar analyst Sean Dunlop. And with more than 33,000 global Starbucks locations, “it’s not surprising that some underperform over time,” he said.

“Unless unit rationalization becomes habitual, particularly closing more recently opened stores, I probably wouldn’t interpret it as a concerning sign.”

And Starbucks continues to open many new stores worldwide. The company said it opened 352 “net new” stores in the fiscal third quarter, bringing it to a record 33,295 stores globally. It expects to add a total of 1,100 new stores this year worldwide, including 600 in China, and has a goal to hit 55,000 stores by 2030.

But some industry players say the accelerated North American store closings are a concern, and the ambitious growth plans are risky in the intensely competitive coffee market. Doug Stephens, founder of the consulting firm Retail Prophet, says the Starbucks brand is in jeopardy of being commoditized as it expands sales beyond its namesake stores into more supermarkets and e-commerce platforms such as Amazon.

“This feels like déjà vu,” Mr. Stephens said, harkening back to when former Starbucks CEO Howard Schultz returned to lead the company in 2008 after an eight-year hiatus, and was forced to close hundreds of underperforming stores. In a 2011 interview with McKinsey, Mr. Schultz said he was “horrified” to learn that many of the stores he had to close on his return had been open less than 18 months. He cited “a lack of discipline,” and criticized his predecessors for “chasing growth” and “making decisions that were kind of complicit with the stock price,” calling it “a very, very dangerous road to go down.”

Mr. Stephens said he isn’t sure if history is repeating itself, but says closing stores to focus on convenience is “watering down the very in-store experience that put Starbucks on the map in the first place. It leaves me worried for their future.”

For investors, the risk is elevated by the company’s rich stock valuation.

“The shares are trading near a 10-year valuation high at 34 times forward price-to-earnings ratio, so I would look for an opportunity at a more attractive valuation,” said Stan Wong, portfolio manager at Scotia Wealth Management. He has owned the stock on and off in the past, but doesn’t currently hold it.

Starbucks shares hit a record US$123.26 on July 23 – an increase of about 15 per cent since the start of the year and 35 per cent since January, 2020, before pandemic lockdowns pounded most consumer stocks. The coffee giant also reported record revenue of US$7.5-billion for its third quarter and boosted its full-year financial outlook.

“Like many consumer discretionary companies, Starbucks is benefiting from the reopening of the global economy and the normalization of consumer behaviour,” Mr. Wong said, adding the company’s My Starbucks Rewards loyalty program and mobile ordering app have helped boost sales.

But the shares have since pulled back to around US$116, as investors worried in part about recent underperformance in China, a primary growth market for Starbucks. China and the U.S. currently account for about 62 per cent of the company’s portfolio, or 5,135 and 15,348 stores, respectively. And many restaurant stocks have fallen back in recent days amid concerns about rising Delta coronavirus cases.

Starbucks CEO Mr. Johnson told investors the recent third quarter represented “the beginning of a multiyear tailwind” for the company, driven by a growing global coffee market that’s expected to well surpass US$400-billion over the next three years based on a compound annual growth rate of about 8 per cent. He also cited growing consumer preference “from mainstream robusta coffee to premium arabica coffee, where Starbucks is the leader,” and said the company has quickly adapted to changing consumer behaviours, including through its digital ordering services.

But the company needs to be careful such changes don’t compromise the in-store experience. Retail consultant Mr. Stephens said some moves in recent years, such as printing out labels on takeout cups instead of handwriting orders, and cracking down on the kind of tattoos and piercings baristas can display while on the job, have hurt “the cultural piece. ... They’re not the cool player in the market anymore.”

Still, Starbucks enjoys a status as a “premium player” in a largely commoditized sector, Morningstar’s Mr. Dunlop added. He said Starbucks continues to provide premium-quality coffee that distinguishes it from the competition, and can charge higher prices. “I think Starbucks occupies a rather unique niche, where they sell extremely convenient, higher-quality coffee beverages at accessible price points – an affordable luxury,” Mr. Dunlop said.

Most analysts are bullish on Starbucks stock: Among 36 analysts that cover it, 22 have a “buy” recommendation, 13 a “hold” and one “sell,” according to Refinitiv. The consensus target price is US$131.40, a solid bump from its current price.

In a recent note, RBC Capital Markets analyst Christopher Carril described Starbucks as a “rare, quality growth among larger-cap consumer peer group,” while increasing his target by US$2 to US$136 after the latest earnings.

“While there are numerous growth opportunities across the consumer investing landscape, [Starbucks] is among only a handful of $100-billion-plus market-cap consumer companies expected to drive sustained double-digit EPS growth in 2022 and beyond,” he wrote.

While COVID-19 will continue to affect the company’s sales this year, Mr. Carril sees “long-term guidance as achievable – and potentially conservative – and setting up for consistent, long-term double-digit growth. "

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