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Starbucks must reverse these two negative trends or its stock could be slaughtered

Brian Sozzi

Embattled hedge fund manager Bill Ackman may want to do his math again on coffee giant Starbucks (SBUX) because it is no longer the high growth retail phenomenon of yesteryear.

And it shows in several important measures of performance that should be near and dear to all investors. Amid increasing competition from upstart coffee chains such as Blue Bottle, an explosion of ready-to-drink coffee options in supermarkets and a barrage of coffee deals from Dunkin’ Brands and McDonald’s, Starbucks’ once unstoppable U.S. sales growth has slowed sharply.

The company’s Americas segment same-store sales have gone from increasing 8% in 2012 to 3% in 2017.  Sales for the third quarter ending July 11 slowed to a meager 1% increase. Store traffic dropped 2%. The fact this tepid stretch of sales has happened amidst Starbucks making a big food push to attract new people and seeing its loyalty members continuing to grow is a major red flag.

Investors will be locked into how sales in Starbucks’ Americas business did in the fiscal fourth quarter, results will be reported on Thursday after the market close. If sales don’t stabilize with Starbucks’ latest effort to market pricier cold brew coffees and various new lunch foods, the stock could react negatively.

Meanwhile, for all its efforts around digital ordering, new store expansion globally and products Starbucks returns continue to be under pressure. In 2014, Starbucks’ returns on invested capital — a measure of how much it earned on investments — stood at a healthy 34.58%. It has trailed off since — returns on invested capital were 28.7% for the fiscal third quarter, according to Bloomberg data.

Not helping Starbucks’ return metrics is higher employee wages alongside its slowing sales, which weighs on profits.

A Starbucks sign is show on one of the companies stores in Los Angeles. REUTERS/Mike Blake

Wall Street wearing blinders?

Wall Street appears to have forgotten about the reality surrounding the former high-flying coffee chain.

Starbucks shares have rocketed 14% over the past three months. Part of the gain reflects enthusiasm around the recent involvement of Ackman. In early October, Ackman, who lost on a Herbalife short bet, revealed a fresh $900 million stake in Starbucks.

“If same store sales and valuation revert closer to historical average levels, we believe that Starbucks shares can more than double over the next three years,” Ackman reportedly said during a presentation at Grant’s Interest Rate Observer conference. “It’s a rare opportunity to own one of the world’s best businesses at a discount.”

That’s a big “if” on same-store sales reverting to historical averages.

Meanwhile in May, Starbucks said it would return $20 billion in cash to shareholders in the form of share buybacks and dividends through fiscal year 2020. The announcement — tantamount to Starbucks acknowledging it’s no longer a growth company — was also embraced by the market.

UBS analyst Dennis Geiger adds that investors are also hopeful Starbucks’ same-store sales growth accelerated in the latest quarter. Geiger cautions that it will “take time” for Starbucks to reverse sales declines in frappes and limited traction in the afternoon hours.

Bottom line: If Starbucks doesn’t reverse its sales downtrend, the new bulls involved in the name like Ackman may get pounded.

Brian Sozzi is an editor-at-large at Yahoo Finance. Follow him on Twitter @BrianSozzi

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