US wages and China closures weigh on Starbucks earnings

Wage rises in the US and Covid restrictions in China will continue to weigh on Starbucks’ profit margins, Howard Schultz told investors on Tuesday, but he said the coffee chain was seeing no sign of customers cutting their spending.

Four months after Schultz returned as interim chief executive to a company struggling with inflation, changed consumer habits and a US unionisation drive, its earnings for the third fiscal quarter to July fell from 97 cents per share to 79 cents, narrowly beating Wall Street’s 77 cents forecast.

Schultz said his conversations with some “partners” in the US had been “raw” but he added attrition rates had peaked in the second quarter as it raised average wages to $17 an hour and doubled training hours for new baristas.

The higher wage bill contributed to a drop in pre-tax income from $1.4bn to $1.19bn, despite record quarterly revenues of $8.2bn, which were up almost 9 per cent year on year.

The period included two months when China’s zero-Covid policies forced Starbucks to close stores or curtail services in its second-largest market, leading to a 44 per cent drop in comparable store sales in a country where it has more than 5,700 outlets.

China was reopening more slowly than expected, said Rachel Ruggeri, chief financial officer. That, coupled with investments in wages and equipment, would lead to profit margins falling further this quarter, she said.

Starbucks’ comparable store sales in North America were up 9 per cent in the third quarter, but operating margins in its largest market fell from 24.3 per cent to 22 per cent as it faced higher commodity and supply chain costs and spent more on pay and training.

Partners in almost 200 Starbucks stores have voted to join a union since December, putting unexpected pressure on company leaders who had considered it to be a generous employer.

Ruggeri said Starbucks had begun to see “increased labour availability and stability”, with internal surveys showing that partners were more engaged.

Some of Starbucks’ problems had been “self-induced”, Schultz said, as he pledged to “reinvent” the business he built from a small Seattle chain into the world’s largest coffee company.

The strategy he intends to announce in more detail at an investor day on September 13 will include investment in new equipment to make it easier for baristas to make the customised cold drinks that now account for about three-quarters of its US beverage sales.

“The premium, customised cold coffee opportunity at all Starbucks around the world is simply enormous,” he told analysts. The ability to customise drinks was raising Starbucks’ average ticket price, he added, and giving it an advantage over rivals with social media-savvy Gen Z consumers.

Schultz said he had narrowed an “extraordinary” list of CEO candidates to “a select few”, adding that he intended to stay “as long as necessary to ensure that the new CEO has a soft landing”.

He hailed the strength of its international operations outside China, where revenues grew by 50 per cent before currency effects. Starbucks was “flourishing” in Italy, Schultz said, where it planned to expand from Milan to Rome and Florence.

Starbucks gave no comment on its expectations for the rest of the year, having suspended guidance earlier in the year. The shares were up 1.3 per cent in after-hours trading.