Did Starbucks' job in China just get tougher? Here's our take on new campaign tariff talk

Published Mon, Mar 11 20244:35 PM EDT

Former President Donald Trump 's promise of tougher China tariffs if elected again could make doing business in the world's second-largest economy more difficult for American companies like Starbucks which are already facing tough competition from lower-cost domestic competitors. "I fully believe in them [tariffs] economically when you're being taken advantage of by other countries," the presumptive 2024 Republican presidential nominee told CNBC in an interview Monday. The campaign rhetoric aside, many China tariffs imposed by the U.S. during Trump's administration have remained under President Joe Biden , the presumptive Democratic nominee. No matter who wins the election — any reaccelerated trade war between Washington and Beijing could hurt U.S. consumer companies in China by stoking nationalistic flames among Chinese buyers to boycott American brands. During Trump's trade war, Chinese consumers turned away from some U.S. goods and services in protest. In 2018, shortly after the initial round of Trump levies, then-Starbucks CEO Kevin Johnson argued his company's coffee was different. Starbucks built "in China for China," he said. The company operates "as an entity in China that's relevant to the consumer, to the culture, and we're playing the long game," he added at the time . SBUX 1Y mountain Starbucks 1 year Shares of Starbucks rose 1% on Monday as investors, perhaps, shrugged off China trade war worries. To be sure, the stock has fluctuated since the start of the year due to concerns about the company's performance in China where economic pressures and aggressive local rivals pose challenges. Such a scenario could fuel skepticism — already a worry among investors — about Starbucks' appeal to a broad swath of Chinese consumers. "I fear they're too expensive for China," Jim Cramer recently said, referring to Starbucks. China is a "no growth country," he added — given its shrinking population, which is a negative sign for businesses like Starbucks that rely on the country's growing consumption. While still massive with roughly 1.43 million, China lost its most populous nation in the world status to India last year. These pressures in China and the U.S. — the No. 2 and No. 1 markets, respectively, for Starbucks — have been weighing on the stock. Historically, Starbucks has traded at a price-to-earnings multiple of between 22 to 30 times forward earnings estimates. Starbucks' current P/E is 22 times, the lower end of that range. Jeff Marks, director of portfolio analysis for the Club, believes that Starbucks "currently reflects a lot that has gone wrong and doesn't anticipate what could potentially go right." To get back its premium multiple, the company "will need to prove it can get China back on track and reaccelerate U.S. comps," he added. The lagging post-Covid economic recovery in China has added to Starbucks' challenges. Economic improvement there, in part, hinges on whether the Chinese government will pass fiscal spending measures that would help boost consumer confidence. Last week, Beijing announced an ambitious economic growth target of roughly 5% in 2024. The Chinese government admits that meeting this target "will not be easy" as deflation, a property crisis, and mounting debt keep a lid on growth. A weaker Chinese economy is driving consumers there to be price-conscious — hence the rise of competitors like Chinese coffeehouse chains such as Luckin and Cotti, which are more promotional than Starbucks and offer big discounts. Luckin, on average, sells its drinks in China for around $1.38 each compared to $4.18 for Starbucks. Starbucks conversely has more of a premium beverage offering that targets middle- to higher-income consumers. Despite the headwinds, Starbucks sees significant potential in China's premium market and aims to differentiate itself through product innovation, new food offerings, and quality in-store and digital experiences. In its fiscal 2024 first quarter , Starbucks saw a weaker-than-anticipated comeback in China, driven by what management called a "more cautious" consumer that led to lower sales and an increased promotional environment in China. The two reasons Starbucks cited were lower sales of higher-priced merchandise in China and targeted promotional investments to personalize offers and reward customers. Peter Saleh, a restaurant analyst at financial services firm BTIG, said he wouldn't be surprised if Starbucks engages in more promotions in the near term since the Chinese consumer "seems a bit more subdued in the reopening" after the pandemic. "You have to battle for those transactions to increase sales," he told CNBC in an interview. "The goal is to get those customers back in your store. Over time, you can migrate them toward full-priced items." On Starbucks' more recent post-earnings conference call, management said they may be operating in an "increased promotional environment," but they are "not interested in entering the price war" with domestic Chinese coffee competitors. Rather, their focus is "capturing high quality but profitable sustainable growth" by being a leader in China's premium market. As the coffee market matures in China, Starbucks believes the industry will undergo a more defined tiered competition dynamic, which would expand opportunities as a high-end brand. At some point, Saleh believes consumers in China will come back and when they do, Starbucks' appeal will still be there."There are certain things you get at Starbucks you can't get elsewhere," he said. "It's more about the innovation of the brand and experience and that's why people choose to go to Starbucks. They've always operated in the premium segment and they've always found success there." However, it may take more time to get there. BTIG estimates that China's economic recovery has roughly six to eight months, at the least, before investors start to see a change in transaction count. But, since Chinese consumers are not off to a strong start in 2024, it might even take longer than that, according to Saleh. Starbucks has nearly 7,000 stores in China, as of its latest reported quarter. It's on track to hit its goal of 9,000 locations there by 2025. The company maintains "full confidence" in the business opportunity in China and continues to see "enormous potential in China's premium market." Only time will tell whether a Trump administration or another four years of Biden will be able to thread the needle to level the playing field with China without hurting U.S. companies' interests there. (Jim Cramer's Charitable Trust is long SBUX. See here for a full list of the stocks.) 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