The Ratings Game

Starbucks might have a bigger China problem than Wall Street thinks

TD Cowen downgrades Starbucks shares

TD Cowen worries about cheaper coffee competitors in China.

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Starbucks Inc. might have bigger challenges in China than investors realize, according to one analyst.

TD Cowen’s Andrew Charles sees the potential for China to be an “albatross” on Starbucks shares SBUX, +1.87%, given competitive pressures and a concerning macroeconomic climate.

“While we were pleased with Starbucks China’s [third-quarter] (June) performance, we see risk that China headwinds are likely to get stronger rather than weaker,” Charles said in downgrading the company’s stock to market perform from outperform Tuesday and cutting his price target to $107 from $117.

The stock was down 1.6% in morning action Tuesday.

Read: Starbucks sees a big rebound in China, but results fail to impress investors

Investors are anticipating the coffee chain’s initial fiscal 2024 guidance, expected to come alongside the next report, although Charles said Wall Street has become “concerned on the China landscape that presumably lacks visibility and could lead the company to avoid issuing China same-store-sales guidance.”

Charles worries about competition from lower-cost players in China, including Luckin Coffee and Tim’s China, which seem to be gaining market share at the expense of Starbucks. Another, Cotti Coffee, has ambitious growth plans.

“All 3 of these concepts have the benefit of franchising to accelerate expansion while Starbucks is 100% company operated,” Charles explained. He expects that “aggressive” deals at coffee shops will continue in China over the medium term.

Read: Howard Schultz steps down from Starbucks board of directors

“We worry the growing size and aggressive discounts offered at competitors are positioned to persist despite obvious questions around profitability,” Charles said. “We worry for Starbucks’ sake that competitors will presumably see benefits from scale as well as declining coffee prices that will sustain the timeline of aggressive discounts.”

Further, he sees various concerning economic signals in China and notes that TD Cowen’s economic team is skeptical that government stimulus will act as a catalyst.

Charles is below the consensus view with his international same-store-sales expectations for China, projecting 10% growth in 2024 and 4.8% growth in 2025, compared with what he says are consensus expectations for 10.5% and 5.4% growth, respectively.

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