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Why Luckin Coffee Stock Could Be A Big Winner

Hyper-growth China retail coffee operator Luckin Coffee (NYSE:LK) made its highly anticipated Wall Street debut on May 17, and it was nothing short of a smashing success. Strong investor demand propelled Luckin to price its IPO at $17, at the high end of its initial $15 to $17 target range. Then, Luckin Coffee stock opened at $25, up nearly 50% from its already boosted IPO price. To be sure, the stock fell off those $25 highs. But, as of this writing, LK stock trades between $21 and $22, or up more than 20% from its IPO price.

Why Luckin Coffee Stock Could Be A Big Winner

Source: Shutterstock

In other words, the Luckin Coffee IPO was a big success.

This success is no fluke. Many people call Luckin Coffee “the Starbucks (NASDAQ:SBUX) of China.” That comparison is pretty accurate. This is the fastest growing and second largest retail coffee operator in China, and is on track to soon become the largest player in the space. At the same time, the China economy is rapidly urbanizing and expanding, and the coffee market in that economy is surging higher.

Altogether, Luckin Coffee is the fastest growing and soon to be the biggest player in a very quickly growing Chinese coffee marketplace. Ultimately, as Luckin continues to expand share in this hyper-growth market over the next several years, Luckin Coffee stock will head higher.

How much higher? Significantly higher. By my numbers, I think Luckin Coffee could be worth in excess of $10 billion one day. The current market cap on LK stock hovers in the $4 to $5 billion range.

Consequently, long-term upside potential in Luckin Coffee stock is quite compelling.

The China Coffee Market Will Be Huge

From a growth perspective, the China economy is second to none on the global stage. This is a massive economy, with well over a billion people, the majority of whom are urbanizing and digitizing at an exceptional pace. The net result is that the economy is rapidly expanding, led mostly by robust growth in the consumer economy.

One part of this consumer economy that is particularly strong is the retail coffee market. Consumer expenditures and retail sales in China are rising at a healthy high single-digit rate. But, the coffee market in China is growing much more quickly, averaging roughly 20% growth on an annual basis.

Still, China coffee consumption per capita is low. Chinese consumers drink about three cups of coffee per year. U.S. consumers drink about 360 cups of coffee per year. That is a hundred-fold difference. To be sure, China GDP per capita and household expenditures per capita are about one-tenth the size of U.S. GDP and expenditures per capita. That explains some of the divergence. But, only about 10% of it.

Thus, the Chinese coffee market is growing very quickly, and has plenty of room to keep growing at 15-20% pace over the next several years.

Luckin Coffee Will Be An Important Player

At the current moment, Luckin Coffee is a relatively small player in the Chinese coffee marketplace. They only operate about 2,400 stores, out of 100,000 coffee houses in China.

But, eighteen months ago, that number stood at zero. Thus, over the past 18 months, Luckin has opened over 2,000 coffee stores, making this company the fastest growing player in the China coffee market.

This robust store opening rate will continue. Luckin Coffee operates on a unique model. They focus on smaller stores, which don’t have much seating area and are focused simply on serving coffee so that consumers are in-and-out. To complement these quick-service-style stores, Luckin has built out a robust online and mobile ordering channel so that consumers can order ahead, run into the store, pick up the coffee and get out quickly. All the while, Luckin offers coffee at industry low prices.

In other words, Luckin is doing the two things it needs to do most: minimize cost and maximize convenience. Because they are doing this, Luckin will inevitably transform into a very important player in the China coffee marketplace.

How important? It’s easy to see this company being as big as Starbucks in the Chinese marketplace. Starbucks has nearly 4,000 stores in China today, and plans to grow that to base 6,000 over the next few years. Luckin consequently has a realistic and visible runway to 6,000-plus stores over the next several years.

This Could Be A $10 Billion-Plus Company One Day

Given the company’s favorable long-term growth prospects, there is an opportunity for Luckin Coffee to one day turn into a $10 billion-plus company.

Here’s the math. Starbucks company-operated stores on a global basis do about $1.3 million in sales per store. Luckin probably won’t be able to do that, given lower China expenditures per capita and their smaller stores. But, about $1 million in sales per store seems doable. On a 6,000 store base, that implies $6 billion in revenues at scale.

Starbucks operates at ~20% operating margins. But, that’s a blended model of licensed and company-operated stores. Luckin’s model is completely company-operated. Luckin also has less scale to lever expenses. That combo broadly implies that ~10% operating margins are doable at scale, which implies roughly $600 million in operating profits. Taking out 25% for taxes, that yields $450 million in net profits.

Based on a Starbucks’ five-year average forward earnings multiple of 25, that equates to a long run market cap target of over $11 billion. Lucking Coffee stock has a market cap of between $4 and $5 billion.

Bottom Line on LK Stock

The Luckin Coffee IPO was a huge success because Luckin Coffee stock has tremendous long-term growth potential. At scale, this long-term growth potential implies that LK stock could more than double from current levels over the long run. As such, for long-term investors, Luckin Coffee stock is the type of stock you want to buy into on weakness.

As of this writing, Luke Lango did not hold a position in any of the aforementioned securities, but may initiate a long position in LK within the next 72 hours. 

Article printed from InvestorPlace Media, https://investorplace.com/2019/05/why-luckin-coffee-stock-could-be-a-big-winner/.

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