Since Luckin Coffee (NASDAQ:LK) went public in May 2019, LK stock is up 103.8% through Jan. 8. If you bought some of its IPO shares and are still holding, that’s quite a return.
Quite honestly, I did not see this coming. While I’ve been burned in the past by being overly skeptical of new IPOs, Luckin was one of my worst calls of 2019.
In September, I called Luckin one of the seven worst IPO stocks of 2019, suggesting that the fast-growing allure of China for North American investors was going to come back to haunt them. In the case of Luckin, so far that hasn’t been the case.
Less than a month later, I included Luckin in a list of 10 stocks to short. Thank god I don’t make a living shorting stocks. I’m much better at recommending stocks that I think will do well than I am those I think will do poorly.
Needless to say, the Luckin story has been a good learning exercise for me. It’s taught me that sometimes the story is just as they say it is. Sometimes it’s not too good to be true. Luckin’s success in 2019 also doesn’t mean the coffee chain’s best days are behind it.
And that’s great news for Starbucks (NASDAQ:SBUX) shareholders. Here’s why.
China’s Coffee Market
One of the biggest concerns I had about Luckin’s tremendous growth is that a tea-drinking nation like China couldn’t support all of the stores that both companies were opening. Add in other international participants such as Restaurant Brands International’s (NYSE:QSR) and Dunkin’ Brands (NASDAQ:DNKN) and you had a recipe for disaster.
Or so I thought.
Despite the fact that China consumed more than 1.6 billion tons of tea in 2014 according to The Atlantic, coffee-industry participants knew there was a great deal of potential for coffee.
“In 2006, there were very few multinational chains that were present. It was very difficult to find a cup of coffee outside a Western hotel or Western area,” Coffee trade expert Andrew Hetzel told US-China Today in June. “[Today] you have representation from many large multinational chains — as you have seen, last week [referring to the opening of Shanghai’s Starbucks Reserve], Starbucks is expanding at a blistering pace.”
Clearly, so too, did Luckin founder and CEO Qian Zhiya.
In late December, research firm Thinknum Alternative Data suggested that Luckin finished the year with approximately 200 more coffee shops in China than Starbucks. The chain also has plenty more on the way.
Not only is China supporting more than 8,400 locations between the two companies, but Luckin recently announced that it is expanding into vending machines that will serve hot beverages and snacks to a Chinese population on the go.
When will it end? Not for a long time.
According to the The Atlantic, people are buying coffee in China despite it being relatively expensive because it allows them to show off how wealthy they are. It’s become a status symbol, unlike tea, which is more of a staple.
“China’s 400 million millennials are the top target for these chains,” US-China Today contributor Rebecca Harbeck stated. “As Hetzel puts [it], many want to manifest their membership in the coffee-sipping middle class. Through incorporating coffee into their day-to-day, Chinese individuals have been able to adopt aspects of Western culture. In the upcoming years, coffee chains will continue to vie for market dominance.”
The Bottom Line on LK Stock
InvestorPlace’s Luke Lango recently stated he thought Luckin stock could cruise to $50 in 2020, almost $10 higher than where it’s currently trading.
His rationale being that Luckin’s earnings per share could hit $4.50 by 2025. Based on a forward price-to-earnings ratio of 16x and a 10% discount rate, that puts its 2020 price target right around $50.
In many ways, the Chinese coffee market reminds me of the cannabis industry. Plenty of potential but execution remains critical to its success.
That said, the rise of the coffee shop in China has got to be good news for shareholders of Starbucks, because it suggests the company wasn’t crazy to focus so much of its growth on one country.
In 2020, I plan to give Luckin far more credit. I just hope it doesn’t disappoint.
At the time of this writing Will Ashworth did not hold a position in any of the aforementioned securities.