Motley Fool Hidden Gems Investing - Starbucks Goes Back to Basics

Episode Date: October 23, 2024

The coffee chain drops some bad news early, while General Motors takes a victory lap. (00:21) Kirsten Guerra and Mary Long discuss: - Starbucks’ bitter earnings - Brian Niccols’ barista-focused turnaround plan - Surprising beats from an old automaker Then, (15:52) Tim Beyers and Mary Long discuss Instacart’s “Caper Cart” technology and advertising business. Visit our sponsor at www.landroverusa.com Companies discussed: SBUX, GM, CART Host: Mary Long Guests: Kirsten Guerra, Tim Beyers Producer: Ricky Mulvey Engineers: Rick Engdahl Learn more about your ad choices. Visit megaphone.fm/adchoices

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Whatever lies ahead, don't change your morning. Let your morning change you. Discover Coffee Plus on Nespresso.com. 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. 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 minted CEO Brian Nichols' first call with analysts in this new role. Before we kind of 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? 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 kind of 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 Nicol, kind of distancing himself from the upcoming results, sort of acknowledging the results right now is like saying, hey, the momentum for these less than stellar results is already in the works. Okay. 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. So key takeaways from these early results are not awesome as perhaps that early drop indicates. Revenue's down, earnings per share is down, same store sales are down in North America, in China, globally, foot traffic's down, average ticket's 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. Nickel came in, and so he only came in in September. And so a lot of these changes are kind of due to the previous management. If we're not grading Nickel on these results, what is it fair to grade him on right now? Yeah. Now is a very squishy time to be evaluating Nickel. It's sort of how you measure anyone's success in a new role, I think. Nickel is a very process-oriented and systems guy, kind of a broad-scale strategic thinker. And the first part of that is absorbing a ton of detail at the unit level, kind of back-to-basics, what makes a single-store tick, what can be better, and then scaling that to more than 15,000 locations. And so far, I think Nickel 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 teams. And 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-plus percent jump in stock price just at the announcement that he would be CEO. So I think shareholders are very are really expecting to hear very clear, detailed plans from him. And for now, his first prepared remarks really seem very focused and kind of 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 got to motivate about 350,000 or so employees to kind of come

along with him on this turnaround. We'll get more into kind of the outlines, the beginnings of this turnaround that Nickel 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 Nickel announced Starbucks would be raising its quarterly dividend. So that dividend will go from 57 cents to 61 cents. 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 kind of more lip service-y? 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. So with Nickel coming in, no one wants to be the leader that breaks that streak unless you have to. So yeah, it's definitely showing that they're committed to it. At the same time, though, Starbucks 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. And so 60% is pretty high, like a little unsustainably high. A healthier target would maybe be in the range of like 30% to 50%. So a bit below. 60% is fine. It's not dire. And Starbucks 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, right? Just make more money, make more net income. Come on, Brian. As if we could just snap our fingers and make it happen. Exactly. Part of the reason for Starbucks' trouble is that it kind of overcomplicated its menu. It leaned more into sugary drinks and kind of 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, Loxman Narasimhan, knew this. He saw this

and dubbed his own reinvention plan the triple shot reinvention strategy. Now that Narasimhan's out, that plan's out. But Nicholson, with a new plan that he revealed to us today, That plan is called Back to Starbucks. Is backwards the right way forward for this company? Potentially, yeah. It's just sort of a classic back to fundamentals where you identify 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. And so I think they need to refocus on

their original mission, which also tends to kind of motivate the workforce behind them to refocus as well. And so, for example, you mentioned one of the things that he's really focused on, Nichols is really focused on now, is that the company has been too focused on their rewards members. And that naturally is because loyalty programs are a huge growth driver for any consumer business. So it's probably easy to fall into the trap of just really focusing on that. But ideally, you should just market to everyone, right? And let the rewards program kind of work its own magic in the background, at least Nichols thinks so. And 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. And I wish I had like an interesting number to kind of compare the depth of Starbucks' menu to Chipotle's. But honestly, I think if you just walk into either store, you can feel it, right? Starbucks has way too much going on. And most likely if Nichols pairs that back, Starbucks will probably lose some customers. You know, someone's favorite drink will be cut. I hope it's not mine, but they will lose some customers on that. And it's just Nichols and his team will have to kind of weigh that against the efficiencies earned from the simpler inventory, the reduced labor, the quicker make times, and kind of the greater throughput. It's really just back to basics to find the right balance again.

What is your favorite Starbucks drink, Kirsten? 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. Okay, so I think this reveals just how complicated the menu is. If you don't even know what your favorite order is, if you're like, I don't know, but the app does. I couldn't tell you what I consume it on a regular basis. I know that it has cinnamon in it and I know that it has oat milk. Okay. It's yeah. Fair enough. I think there's triple digits of combinations that we could make from that considering how many different options there Starbucks. One of the things that stuck out to me in this turnaround plan is this real emphasis on

baristas and quality and people, people, people, people. Nichols talked a lot in this six-minute video that kind of 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 like 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 handcrafted beverage prepared quickly and with care. And this is the part that like in my notes, I bold italicize underline and handed directly to

the customer by our barista. This seems to me like it's a pivot, not just from, okay, 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, et cetera. 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 Nichols is pointing to here? I agree with you. I don't

think we'll see that metric. Shame. Like I've said, it's really a balance. Most companies are moving towards efficiency. What we've seen here is a company that has over-indexed to efficiency, So we're pulling back a little bit. Um, I think ultimately it's a very delicate balance. I think what we watch honestly is just kind of 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 is even worse down, they've probably got that formula wrong and need to rebalance. Um, and so I don't

know, like I went this morning and my drink had like a full inch and a half of air at the top, uh, the drink that I, you know, 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. So if, if I think it's fair to say, at least from my anecdotal perspective, efficiency has certainly gone too far here. Um, 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. So revenue is just the first and foremost thing I would be watching here. 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. Kristen, when we were talking this morning about potential topics to discuss, you said that GM surprised investors. What about this was surprising? Well, it's an old legacy mass market U.S. 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. And Monday is up about 110%. So anyway, we all win. But 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 sort of a continuing slow decline for GM. I kind of just factored it out, right? And so naturally, any news to the contrary is kind of going to inject a little hope for re-stabilizing that market and add kind of a corresponding little boost to the share price.

So, Kristen, what I'm hearing is this was a surprise for everyone else, but not for you. don't bet against Kirsten. I told you. So, okay. And 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, Volkswagen, all in the red. What is GM getting right that other car companies are missing right now? So the big macro does apply to all of them. All of these automakers are in a tough spot with the sentiment volatility kind of toward EVs and the demand softness that has affected all 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. So they are kind of 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 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 with all 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 kind of ease range anxiety. So that's a big focus, of course. And 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 count by almost 14%. It's made some big repurchases, indicating it kind of 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. And so if that's not a sign of confidence, I don't know what is. 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? Sell more coffees, sell more cars. I think I should be a CEO and you as well. You get it. More money, more money. Kirsten, thanks as always for joining us today. Pleasure talking to you. Thanks for having me, Mary. The next great ad campaign might be coming to you from your grocery cart. Up next, Tim Byers joins me for a look at an underappreciated side of Instacart's business. This family is on the brink of civil war. On September 18th, Mobland, the hit original series, is back on Paramount+. We are the Hooligans.

Don't know the name? and googlers from the underworld of guy richie do you want to step up the ladder i want karma dead starring tom hardy pierce brosnan and helen mirren do i have to do everything myself mobland new season hits september 18th on paramount plus 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 Fiji Simo has since called Caper Carts the centerpiece of Instacart's mission to help grocery partners, quote, deliver the best omni-channel experience. Tim, when I think of

the grocery store, I kind of think of it as a single channel, like multi-aisle, but single channel experience. What does an omni-channel experience look like at the grocery store? Yeah, it's an interesting one, Mary. But let's start with what omni-channel means. It means engaging with customers across several different channels. So in this case, channels are things like in-store, in-app, out in the world, or just generally online. So any place you are, think of a channel as a place of where you are engaging with a product or service. So caper carts are interesting in that they automate the shopping experience to a degree. So 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 kind of thick. It kind of has trying to look a little bit hip, and it's got this, you know, it's outfitted.

And so you start shopping the way you always would. And 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. So it just knows automatically what you have put in your cart, how much it costs, and it keeps a running tally for you. So if you think about all the data it is collecting as you shop, that's pretty mind-blowing. And what does that mean? Like when you are – and this is where the omni-channel 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 so you know maybe you linger in an aisle and that might signal that 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 so all of this stuff is super interesting and it can be used to make the shopping experience more interactive across channels so let's say one thing this happens take that example mary where you're lingering let's say you're lingering in the aisle where it's for like you know hair care sundries like toothpaste and you're lingering in that aisle and ultimately you put a three pack of colgate toothpaste into your smart cart that's data that instacart has that a brand like if if crest you know i'm not i don't

remember what is the the holding company for the crest brand but whoever that is let's assume it's procter and gamble i'm just making stuff up here i think it's probably png right so then png 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 know, you're getting crest, you know, they start showing up. Maybe you have different, you know, 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 omni-channel way. You took data from one channel and you made it useful across lots of channels. Does that make sense? It does make sense. And 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. But what you're describing is kind of an entirely different segment. It's really more advertising. So 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. Advertising is a big piece. I think of it as the glue that kind of makes the Instacart experience a little bit stickier because you can create multiple wins with partners. So brands that want to sell more of their products will advertise on Instacart. And the way to think about advertising inside of Instacart, Instacart is, let me take a step

back for a second. Instacart's a two-sided marketplace. So what you're doing is you have demand, you know, so shoppers who want goods, right? That's demand. Then you have supply. You have grocery chains and other retailers that supply groceries, sundries, all of this stuff. Instacart sits in the middle, so 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 and another participant in that platform are brands so like crest you know it was like hey we want to sell more crest and if we want to sell more crest we need to know how it's selling where it's selling under what conditions and so instacart

is a particularly, I would say, impressive partner that has that data that just makes it stickier. So they will, for example, and classically, like when you're talking about grocery selling, you know that eye line, you walk down the aisle, we've all done this, right? And you have the eye line that is the most important space in the grocery store in any aisle and so those brands pay a premium for that and they usually pay it to to the grocery store in instacart the the eye line shelf space is the offer that pops up in the app you know carrots available for you know and it'll have something like $199 a pound slash through $179 a pound. And now that's an offer that is available there inside of Instacart. It's shelf space. And so this advertising business is really

important. It's important for brands. It's important for retailers. And the more that shoppers use those offers, kind of engage with that shelf space, the more signals they send about products and about intent, about who they are as a shopper. So 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? So 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 kind of 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 kind of returns do you expect to see from that kind of spending? Well, to be fair, a lot of that dramatic increase is due to equity granted to employees and investors before the IPO. This is still a fairly recent IPO. And 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 vest just a mountain of stock. And they did. And so they had to realize huge amounts of stock-based

compensation expense upon going public. So it looks terrible right now. It really looks bad, but it's really not, because this is a one-time event. So there's no question there's going to 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 Capercarts business, upgrade the app, improve shopper efficiency. Again, this is a two-sided marketplace where a lot of people are depending on the company need to make more money at reasonable margins. There's simply no way to do that without continuing

to innovate. So I'll give you a quick example here. Instacart has built out a machine learning capability. So this is not AI, but it's a form of AI that helps to predict when items are available in store. And this is really important because one of their constituencies, so again, you got groceries, you got grocers, right? 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. And so 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 to 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, an order from, say, you, and then 60% of the order can only be filled because you thought that all of these things were available, and 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. So 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. Like everybody has to make more money with Instacart. So 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. Tim Byers, as always, it is a pleasure talking with you. Thanks so much for chatting with me today. Thanks, Mary. 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