Life's Smallest Luxury is not Lost on India
Starbucks Q2 2023, China, and international tailwinds
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After opening the first two official Apple stores in India this year, Tim Cook is finally calling the country a major focus; suggesting they are at a tipping point. When I suggested that people were sleeping on iPhone demand in India last week, it was met with some pushback. Some understood that while middle-class India is a small percentage of the 1.4 billion population, their numbers are large (and growing). Others said things like “go to India and you’ll realise you’re wrong”, “look at GDP per capita” or “Indians don’t like luxury goods”. In my opinion, they are missing the forest for the trees. Forgot the ones who can’t afford an iPhone, and focus on the ones who can, and will, purchase one.
One need only look at the failure of the Tata Nano to see that Indians are not all cheapskates. The project was established to give every Indian an affordable car. Something that was unforeseen, however, was that Indians didn’t want to be seen driving the nation’s cheapest car. You’ll see larger Tata models on the roads here, and even an ungodly amount of motorbikes, but also a litany of Audis, BMWs, Jeeps, and Mercedes. Indians like big cars, and they like owning more than one of them. You can be an armchair analyst and cite the macroeconomic data, or you can come to India yourself and see the reality. I am being loose with the term luxury here, of course, more so hinting at life’s smaller luxuries. What could be a stronger siren for small-time luxury than Starbucks coffee?
The Red State
Much to people’s surprise, Starbucks is a business that shouldered the pandemic reasonably well and is now viewing the ordeal (mostly) from the rear-view mirror. Record sales are being hit with each passing quarter in North America, where comparable sales were up 11% in Q2 2023. The international business managed 7% comps (including China) and an impressive 14% revenue growth (excluding China). While margins still have a way to go before they return to pre-pandemic levels, the company is faring well under new management. The world is preoccupied with Starbucks’ China growth runway, and for good reason. As the second quarter marked a “turning point” for China, Starbucks may finally be about to capitalise on the 1,500+ stores1 they have constructed in the region since the outbreak of the pandemic; now totalling 6,243. Yet, despite accounting for 34% of company-operated stores, China has only accounted for ~10% of the revenues so far in 2023. There continues to be a mismatch between the segment’s footprint and its monetisation rate. The recovery won’t be linear.
I believe China could be a $10 billion business for Starbucks one day, and there are signs the business may be coming back to life. Revenues were up 3% in the quarter, and comparable store sales were up 3%, helped by a 4% increase in transactions. The positive same-store sales comp was the first since mid-2021 and rewards members have also begun to pick up after suffering losses in 2022. In the weeks following the Q2 report, Laxman remarked that China's rewards members reached all-time highs, which we can assume means they have surpassed 18 million.
Mobile ordering in China reached 47% in the quarter (up from 43% last year) and “delivery demand remained robust even after consumer mobility has recovered”. The rewards system in the US (which accounts for 57% of company-operated store revenue) has been highly effective. While the recovery from China in the first half was stronger than anticipated, management refrained from raising guidance on account of the difficulties and lingering uncertainy in predicting a Chinese recovery. They appear to have learned from their over-optimism in years past. Last month I askedfrom for his two cents on China’s Recovery, here is what he had to say:
“I think China’s recovery is solid, especially on the consumer side. The Chinese economy can be divided into three parts:
Exports: China’s export industry is suffering from the post-COVID cliff of lower cash handouts in developed markets and reduced need to spend for items at home.
Construction: China’s construction industry is weak after the government reduced credit to private property developers through its so-called “three red line policy” introduced in 2020 and implemented in 2021. I doubt we’ll ever see a return to the construction activity last seen in 2021. That’s going to weigh on the economy.
Consumer: The Chinese consumer is definitely on a path to recovery. The March 2023 number for China’s official retail sales value exceeded expectations by a wide margin, suggesting the recovery is on the way. Restaurant receipts are recovering fast. Consumer confidence is almost back to the pre-zero-COVID days.
Meanwhile, outbound travel is accelerating nicely since China’s border reopening in January 2023, though perhaps slower than some investors initially expected. The number of outbound flights is now about 480 compared to 1,200 before the pandemic started in 2019. But I think we’ll reach close to 600 flights by mid-year 20223. I’ve also seen anecdotes that Chinese tourists spend much more in Europe over the past month, suggesting that the duty-free sector should see sequential improvement in revenues. What could serve as a roadblock in overseas duty-free spending is that China’s border controls have become much tighter since 2021. The “daigou” business, whereby agents bring smuggled goods across the border without paying tax, has been hit hard by this crackdown. Also, Chinese can now shop duty-free on Hainan island, which is cheap to fly to and doesn’t require a visa. The affluent Chinese have most of their savings in property, and property prices are no longer rising. That could weigh on luxury goods spending. But in general, luxury consumption is a function of credit growth, and we’ve seen a significant acceleration in year-on-year new loan issuance in the first quarter of 2023. That should, in theory, support the luxury goods market”.
Michael’s comments reaffirm that China’s recovery will be bifurcated, but that there are green shoots emerging from the wreckage.