Starbucks (NASDAQ:SBUX) is one of the world’s most recognized quick-service restaurants with over 28,000 locations worldwide. The high consumer demand for their premium coffee has led to a Starbucks on nearly every metropolitan corner – or so it seems.
Not all of their stores, however, are making the grind. Starbucks announced in a recent press release that they plan to close 150 stores in 2019. 150 Out of 28,000 hardly seems to be a matter of concern, but this figure is three times their annual store closure average. In a typical year, Starbucks normally closes only around 50 stores.
Why Is Starbucks Closing 3x The Number Of Stores In 2019?
Having multiple locations within a limited demographic area creates an over-saturation of the market and leads to cannibalism of each other’s profitability. As better locations become available, older non-performing stores are traded out when their leases expire to make room for more income growth at the superior location.
Once in a while, a Starbucks location will not perform as well as their feasibility study indicated. If that location cannot meet brew up enough income, the corporate office will not accept the next renewal option.
The New Starbuck's Initiatives
Starbucks will be implementing several new initiatives in 2019 which will affect income growth and expansionary decisions.
- Focus will be shifted away from over-caffeinated urban markets and into unaddicted markets in the South and Midwest.
- Sugar and calorie dense coffee offerings (think Frappuccinos) will move over and make way for more health conscience offerings such as teas and natural refreshers.
- Continued vigorous expansion into foreign markets – predominately China – with less aggressive expansion in the U.S.
- Digitizing coffee through their new app and their redesigned Starbucks Rewards program.
How Will Starbucks' 2019 Initiatives Affect Stock Investors?
Opening up new under-caffeinated markets will position Starbucks to unlock previously untapped income sources. Acting on health and wellness behavioral trends will keep their customer base solid. Plus the rewards potential for caffeinating over 1.3 billion Chinese seems unimaginable.
This shift in perspective, however, is coming at a cost. The predicted 2018 third quarter sales growth of 1% is a far cry from Wall Street’s estimate of 3%. It will be the company’s weakest sales performance in nine years, according to Bloomberg News. The growth rate over the next two years is forecasted to increase somewhere between 6 to 10% annually. This is in harmony with their average growth over the last couple of years.
Starbucks wants to ensure that its shareholders do not take the temporary profitability decline as a sign of weakness. They will be dramatically increasing their payments to shareholders through the 2020 fiscal year. Dividend payouts and buybacks will total $25 billion – a $10 billion increase over previous payouts.
These actions seem to be following a 10-year trend. Back in 2008, Starbucks closed 600 of their underperforming stores and worked hard to rebuild brand trust through the “My Starbucks Idea” exchange and social media-based marketing. It was a good move. Shares hit rock bottom in November 2008 at $4.47 but then nearly doubled one year later at $11.37. Now, 10 years later, the 52-week high crossed $61.00.
Stock price inconsistency since 2015 indicates that another strong initiative is needed. Shareholders love consistency - but companies that do not change, grow, and reorganize eventually begin to taste like stale coffee - something Starbucks abhors.
Should a triple increase in store closings concern shareholders? Absolutely not. Underperforming leases that are expiring will simply not be renewed. Those that need to be closed before the lease expiration will be paid their early termination fees and Starbucks will cut their losses and move on to what’s brewing in better neighborhoods. The saved rent will be funneled into more profitable and less saturated markets.
How Will Starbucks' Store Closings Affect Real Estate Investors?
Similar to many other national corporations, Starbucks does not own their individual locations – even their freestanding buildings. They prefer to lease rather than own. The 2019 directive to close 150 stores means that a minimum of 150 property owners are going to be dealing with a devastating vacancy of a tenant that pays an average of $60.00 per square foot for a 2,000 square foot building.
Should Starbuck’s reorganization actions deter investors from purchasing properties with a Starbuck’s tenant? Not necessarily – if you know what to watch out for. While Starbucks is an investment grade tenant with an upper medium investment rating, they are known for playing hardball when it comes to lease negotiation. Investors need to be aware of their new negotiation tactics.
A typical lease with Starbucks will be for an initial 10-year term with several 5-year options and 10% rent increases at the start of each option. Most leases are net-net lease which will hold the landlord responsible for roof maintenance and structural repairs. This should not be much of a concern for investors since most locations will be of new construction and should carry a roof warranty. If so, then investors would effectively be looking at a NNN lease situation.
Investors will, however, want to keep a keen eye out for their newly demanded termination clause. New leases will allow Starbucks to terminate the lease in year 5 if they do not meet a certain dollar amount in sales. Also, watch out for clauses allowing sub-lease arrangements. Both of these clauses will increase the risk of a Starbucks leased real estate investment.
We are also noticing that prior to the termination of the initial 10-year term, the Starbucks Corporation has been approaching landlords about signing a new 10-year lease rather than exercising their renewal option. Typically at the 10-year mark, Starbucks will renovate and upgrade the store. This usually requires significant capital investment to bring the store in harmony with their latest design layout. A new 10-year lease helps to ensure a return on their capital investment by securing the location.
While this sounds appealing to a property owner, there is a darker side to their offering. A new 10-year lease will allow them to try and sneak in the termination and sub-let clauses which may not have existed in the initial lease agreement.
An early termination clause will add a degree of investment risk. Yet, this creates a case of the coffee cup that is half empty versus half full. While an early termination clause gives the tenant a way out, knowing that Starbucks will be spending considerable funds to renovate the building and sign a longer lease indicates that they expect the location to remain profitable. Investors can create a little insurance of their own by including with the early termination clause a required 6-months’ notice and a sizable early termination penalty.
The Starbucks Pain In The Assets
Like many national corporations, Starbucks rents their locations rather than owns them. This allows the company to focus on cash flow rather than equity on a balance sheet. The difficulty faced by Starbucks now is that their long-term lease agreements pose a significant legal responsibility.
Early termination of a 10-year lease will result in either significant penalties or continued rental payments until another viable tenant is located. This creates a significant direct income loss. The closure of 600 stores back in 2008 cost Starbucks over $340 million in charges and write-offs.
For the majority of Starbucks’ locations, they will be bound to adhere to the lease – as painful as it may be – until the term expires. Locations that cannot support renovation to include a drive-thru window may not be renewed. Many of the 150 store closings will most likely be older buildings without drive-thrus – an acceptable pain in the assets in order to caffeinate the world!