Small but rapidly expanding Chinese coffee retailer Luckin Coffee (NYSE:LK) hit the public markets with a May 2019 initial public offering (IPO) at a price of $17 per share. In the days following its debut, I called LK stock a long-term winner.
A few months later, I doubled down on that thesis, arguing that the coffee chain is a great growth stock to buy both now and for the long haul.
Indeed, Luckin Coffee stock today trades hands at $40, up a whopping 135% from its IPO price. That’s an impressive rally, especially considering that the 58-stock Renaissance IPO ETF (NYSEARCA:IPO) is flat over that same stretch.
In other words, while IPO stocks have fallen flat over the past six months, LK stock has not. Instead, it’s more than doubled. There’s a reason for this out-performance, and that reason is that Luckin Coffee has consistently been undervalued relative to its enormous growth opportunity in China’s rapidly expanding retail coffee market.
Fortunately for bulls, all of this remains true today. Luckin’s growth drivers remain robust. The growth opportunity remains large. And, importantly, LK stock remains undervalued relative to the company’s long-term growth potential, even after a 100%-plus rise in 2019.
Thus, a new year won’t mark the end of the LK stock rally. Instead, it will be an extension of the rally. In 2020, LK stock can and will continue to head significantly higher. Prices above $50 are not out of the question for this growth stock over the next twelve months.
Fundamentals Will Remain Strong
The fundamentals underlying LK stock are very strong, and will only improve in 2020. As What’s on Weibo, a website that tracks social media in China, noted, in “the motherland of tea, coffee is rapidly gaining in popularity.”
The story here is pretty simple. Chinese consumers don’t drink a lot of coffee. They average about three cups of coffee per year. Here in America, U.S. consumers drink about 360 cups of coffee per year. But, China’s consumers, especially the young ones, are starting to adopt Western coffee drinking habits in a big way, and coffee consumption rates throughout the country have been growing at a steady 20% pace for several years. Further, because this is a youth-driven trend, it is likely to persist in a big way for a lot longer.
That means that over the next decade, there will tremendous growth in China’s retail coffee market. Luckin Coffee is at the heart of this growth market. It’s the biggest player in the market, bigger even than Starbucks (NASDAQ:SBUX). Its presence is growing rapidly, opening 2,000 to 3,000 new stores a year across the country. And, Luckin employs a highly attractive and unique business model which is winning over Chinese consumers with lower prices (they discount their coffee), easier access (they operate very small stores, so their stores can fit essentially anywhere), and faster coffee prep times (they employ an “order ahead” model, where consumers order their coffee drinks ahead of time on their phones, and simply stop into a Luckin store to pick-up their already made drink).
Given these favorable characteristics, Luckin Coffee projects to become the “Starbucks of China.” Starbucks operates about 15,000 stores in the U.S. for some 340 million people. Luckin Coffee presently operates less than 4,000 stores serving China’s more than a billion people. That makes for a very long and quite robust long-term growth runway. Coca-Cola (NYSE:KO) unit, the U.K.’s Costa has 344 branches in China, and plans to have a total of 900 stores open by 2020.
Luckin Coffee traveled down that growth runway in 2019 at blitzing speed. It will continue to do so in 2020, opening thousands of new stores in the new year. Average monthly customers and average ticket size will continue to roar higher, boosted by the fact that China’s economy will rebound in 2020 on the back of easing trade tensions. With both of those growth drivers set to remain healthy, Luckin’s revenue will continue to soar higher in 2020, accompanied by sustained margin expansion. That combination will keep LK stock on a winning path.
Luckin Coffee Stock Could Cruise to $50
My numbers indicate that Luckin Coffee stock could power its way to $50 in 2020, about 27% upside from the current $39.36 level.
The numbers are a bit complex. But, to put it simply, there are three big growth drivers here — unit growth, transaction growth and margin expansion. All three of those metrics will work together over the next five years to drive Luckin’s enormous revenue and profit growth.
On the unit growth front, Luckin is vowing to open at least 10,000 stores by 2021. From 2019’s projected ending store base count of 4,500, that implies about 2,750 new store openings per year. That seems entirely doable, given that they are already opening about 2,500 new stores per year, and that 10,000 really isn’t that many coffee stores for a billion-person country. Looking out to 2025, I entirely expect 2,000 to 3,000 new stores to remain the norm, and for Luckin to grow its store count in China to about 20,000.
With respect to transaction growth, the number of purchases per Luckin coffee house per year should grow as more and more Chinese consumers become regular coffee drinkers over the next few years. Sure, Luckin stores won’t ever be as busy as Starbucks stores on a per unit basis, because Chinese consumers will never be as heavy coffee drinkers as U.S. consumers. But, considering that total transactions rose nearly 500% year-over-year last quarter, there is significant runway for transaction volume to keep growing at a heady pace for the next several years.
Meanwhile, Luckin runs at negative profit margins today, but that’s a temporary phenomena during this hyper-growth phase. Eventually, Luckin will be past the days of doubling its store base every year. Once those days do pass, expense growth will moderate, and Luckin will look more like a stable retail coffee chain. We know those are profitable businesses with 15%-20% operating margins — see Starbucks and Dunkin’ Brands (NYSE:DNKN). Consequently, long term, Luckin is heading for 15%-20% operating margins.
When you put all of that together, my modeling suggests that Luckin has a realistic opportunity to hit $4.50 in earnings per share by 2025. Based on a market-average 16x forward earnings multiple and a 10% discount rate, that equates to a 2020 price target for LK stock of nearly $50.
Bottom Line on LK Stock
Luckin Coffee is a long-term winner, that’s still in the early stages of a huge multi-year growth narrative, with healthy operational tailwinds heading into 2020, and with a stock price that continues to trade at a discount to the company’s long-term profit growth potential.
In other words, LK stock is going higher in 2020. Don’t fade this record rally. Stick with it.
As of this writing, Luke Lango was long LK.
