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Starbucks Will Get Back on Track in China With Alibaba Delivery Deal

Adam Levine-Weinberg, The Motley Fool

In late June, shares of Starbucks (NASDAQ: SBUX) plunged after the coffee purveyor cut its guidance for its third fiscal quarter and 2018 fiscal year. Starbucks pointed to a slowdown in comp sales growth in the U.S. -- but even more concerning for many investors was a reversal in the previously fast-growing China market.

However, last week, Starbucks officially unveiled a new comprehensive partnership with Alibaba (NYSE: BABA) in China. With the massive Chinese retail and tech conglomerate on its side, Starbucks' growth in China is likely to reaccelerate in 2019.

China comp sales growth comes to a crashing halt

Not too long ago, Starbucks seemed to be firing on all cylinders in China. For the company's 2017 fiscal year -- which ended on Oct. 1, 2017 -- comp sales surged 7% in China, including an 8% increase in the fourth quarter. Growth remained elevated in the first quarter of fiscal 2018, as China comp sales rose 6%, driven entirely by transaction count.

A delivery worker leaving a Starbucks cafe in China

Image source: Starbucks.

These strong results encouraged Starbucks to take full control of its business in China (rather than operating through a joint venture) and accelerate its growth plans. The company plans to add 600 stores annually in China over the next several years. By fiscal 2022 it will have around 6,000 locations in China, double its fiscal 2017 store count there.

However, China comp sales grew just 4% in the second fiscal quarter and then declined 2% last quarter, roughly in line with the updated guidance Starbucks' management provided in late June. It's not surprising that this abrupt slowdown spooked many investors.

What happened?

Some experts have attributed Starbucks' recent challenges in China to the loss of the brand's luster with consumers. "'The problem is Starbucks is no longer viewed as an aspirational brand,' said Shaun Rein, managing director of Shanghai-based China Market Research Group," according to The Wall Street Journal.

However, it's hard to reconcile this explanation with the rapid change in Starbucks' comp sales trend over the past year. Could Starbucks really have gone from being one of the hottest brands in China to "out of fashion" in less than 12 months? (That would be especially odd given that last December, Starbucks opened an upscale Starbucks Reserve Roastery in Shanghai -- and it immediately became the company's No. 1 location by sales.)

The bustling interior of the Starbucks Reserve Roastery in Shanghai

The second-ever Starbucks Reserve Roastery opened in Shanghai last year. Image source: Starbucks.

Furthermore, Starbucks executives reminded investors on a pair of conference calls in late June that the company is adding new locations in China at a rapid pace. First, this means that there has been some cannibalization, as sales migrate from existing stores to new locations. Second, it means that Starbucks' transaction count in China is still growing quickly, even with comp sales in negative territory. That doesn't make it seem as if the brand has fallen out of favor.

Instead, Starbucks blamed its third-quarter slowdown in China primarily on not having delivery services available. The government recently cracked down on third-party delivery services that had been taking orders from customers and sending their employees into Starbucks cafes to order and deliver those items. This situation put Starbucks at a disadvantage relative to competitors with their own delivery services (or official delivery partnerships).

The new partnership can turn the tide

During its conference calls in June, Starbucks said it was in talks with a major Chinese tech company to form a delivery partnership.

The Alibaba deal announced last week fits the bill -- and then some. Starbucks will start piloting delivery service in Beijing and Shanghai next month, using Alibaba's Ele.me platform. By year's end, the delivery program will be rolled out to 2,000 stores in 30 cities across the country.

However, the Alibaba partnership is about more than just delivering drinks from Starbucks cafes to customers. Starbucks will establish delivery kitchens in Alibaba's Hema supermarkets starting in September. This move will allow it to increase its delivery capacity while enhancing the environment for customers in its cafes by avoiding a constant stream of delivery workers picking up orders.

Starbucks will also integrate a "virtual store" into all of Alibaba's popular apps and services, including Taobao, Tmall, and Alipay. Doing so will put Starbucks in front of at least 500 million active users of these apps, according to Starbucks CEO Kevin Johnson.

Investors won't really start to see the impact of these initiatives on Starbucks' business in China until 2019. However, integrating in a deep way with a retail/tech powerhouse like Alibaba could turbocharge Starbucks' growth in China. As a Starbucks shareholder, I am eager to see the results of this exciting new partnership.

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Adam Levine-Weinberg owns shares of Starbucks. The Motley Fool owns shares of and recommends Starbucks. The Motley Fool has a disclosure policy.