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Here’s the Bad News: All the Good News Already Is Priced into LK Stock

Luckin Coffee (NASDAQ:LK) stock has been skyrocketing since its May 20, 2019, IPO. LK stock started trading then around $18 but it is now priced above $50 per share. What a ride!

Here's the Bad News: All the Good News Already Is Priced into LK Stock
Source: Keitma / Shutterstock.com

There are now more Luckin Coffee shops in China, where Luckin is based than there are Starbucks. The growth in the company and its revenue is translating into huge gains.

Moreover, Luckin just raised more $440 million in more capital in a secondary offering at $42, but that didn’t slow it down. LK stock is now at an all-time peak of over $50 per share.

That gives Luckin a market value of $12.6 billion. This is a huge multiple in relation to its revenue, even though revenue has been rising quickly as well.

A Closer Look

Luckin Coffee - Revenue History
Source: Mark R. Hake, CFA

For example, revenue as of Q3 was $208.9 million. The company guided to revenue for Q4 2019 as high as $313.4 million.

This represents a gain of 50% sequentially. And that is on top of its previous quarterly rise of 57.7% in revenue.

It puts Luckin Coffee on a run rate revenue of $1.2 billion (i.e. $313.4 million expected in Q4 times 4). But the truth is growth will likely occur over the next 4 to 8 quarters.

For example, let’s assume that growth continues over the next 8 quarters at 25% quarter-over-quarter. That would mean the revenue in two years would be 4.96 times the present expected rate of $313.4 million.

So revenue in Q4 2022 would be 5x $313.4 million, or $1.55 billion. That would make annual run-rate revenue at $6.2 billion.

Therefore the present market value of $12.6 billion does not look that expensive. The market always discounts the future. Today’s valuation puts the LK stock on just 2 times revenue 2 years in the future on a run-rate basis.

Growth and Expansion

Luckin Coffee - Store Count Growth
Source: Mar, R. Hake, CFA

Luckin Coffee’s store growth has been phenomenal. You can see in the chart below that the number of stores has been skyrocketing.

In the past three quarters, the store count has risen over 23% each quarter. This has been helping to drive Luckin Coffee’s revenue.

The company has also been moving into serving tea since July 2019 when it was introduced nationwide. During that time the company says the number of servings has risen 8.8 fold. Luckin has also been opening Luckin Tea stores that focus solely on tea.

Valuing LK Stock

So far Luckin Coffee is not making a profit. The company says it now has a store operating profit margin of 12.5%.

But Luckin still lost$74 million in net income during its latest quarter on revenue of $215.7 million. That is an operating loss margin of negative 35%.

But that loss is significantly lower than the loss of $95 million on revenues of $132.5 million in Q2. That represented a negative margin of 75%. So in Q3 the loss, in margin terms, improved by more than 50%.

The market assumes that as revenues rise, as they are expected, the losses will turn into profits. This is what the term operating leverage refers to.

Using Operating Leverage to Estimate Earnings

Analysts use that term to describe the fact that profits rise faster than costs as revenues rise dramatically. Luckin Coffee is expected to show significant operating leverage in the next few quarters.

But, the issue is whether LK stock already discounts that future. I have shown above that the market assumes that revenue will rise at least 25% each quarter for the next eight quarters.

At the present time, the market assumes revenue will reach a run rate of $6.2 billion by the end of 2021. Assuming operating leverage comes into play the profit margin might reach the store margin of 12.5% less operating overhead and taxes.

Let’s assume that overhead and taxes take at least 40% of that margin. So we might expect a net margin of 7.5% by the end of 2021, at least on a run-rate basis. That means the profits would be $465 annually.

Given the LK stock market value of $12.6 billion, the forward price-to-earnings ratio will be 27 times. That is already pretty high. It will also be trading at 2 times revenue.

So the bottom line is that at today’s price a lot of growth and profitability is already in the LK stock price. Moreover, the company has to perform and reach these levels.

If it appears that growth will be even higher, maybe LK stock should be valued higher. But at today’s price, a lot of good news is already discounted from the future.

As of this writing, Mark Hake, CFA does not hold a position in any of the aforementioned securities. Mark Hake runs the Total Yield Value Guide which you can review hereThe Guide focuses on high total yield value stocks. Subscribers a two-week free trial.

Article printed from InvestorPlace Media, https://investorplace.com/2020/01/lk-stock-rising-fast-overvalued/.

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