The Coronavirus Might Not Be Luckin Coffee’s Only Concern

China’s coronavirus outbreak has hurt Luckin Coffee (NASDAQ:LK) in recent weeks. Since hitting a 52-week high of $51.38 on Jan. 17, LK stock has fallen nearly 25%.

The Coronavirus Might Not Be LK Stock's Only Concern

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The drop is mainly due to the operator of coffee shops being forced to close stores. Overall, though, Luckin is up 91% over the past 52 weeks. So, its supporters are likely to view this slight fall as merely a bump in the road.

Having come so far, so fast, I’m inclined to believe the fall in its share price has less to do with the coronavirus and more to do with the fact it is overvalued compared to Starbucks (NASDAQ:SBUX) — its much stronger coffee rival.

Currently, Luckin trades for more than 18 times sales, while Starbucks is selling at less than four times sales. Analysts and other experts — including InvestorPlace contributors — are all over the map when it comes to handicapping this particular horse. So if you’re looking for a unanimous agreement on Luckin, I don’t think you’re going to find it.

However, I personally think it’s essential investors consider some of non-coronavirus issues facing Luckin before buying shares of LK stock.

Luckin Wants 10,000 Stores By End of 2021

According to Morgan Stanley analyst Lillian Lou, the company continues to push for 10,000 stores in China by the end of 2021, up from 4,500 at the end of 2019. Furthermore, the analyst believes the company will shed more light on its expansion plans in the upcoming weeks.

That said, getting to 10,000 stores from 4,500 in two years is not going to be nearly as easy as it was to go from nothing to 4,500 in approximately two years. The real estate issues, alone, could prevent Luckin from meeting its aggressive goals. 

Additionally, it’s not as if it’s the only coffee company looking for space to lease in China. Beyond Starbucks, there are another handful of international competitors that could make it very expensive for the company to build out its network of stores.

LK Stock’s Unwarranted Price Hike

Keybanc analyst Eric Gonzalez believes Luckin will bounce back quickly from the coronavirus outbreak stating, “We think it’s a transitory issue that will prove to be a buying opportunity for the shares over time.”

On Jan. 16, Gonzalez raised his price target on Luckin stock from $32 to $56 while maintaining his “overweight” rating. This increase occured because of “strong core business momentum and the addition of new revenue streams.”

“Despite the stock’s upward momentum, we believe the profit potential of these channels implies little to no multiple expansion has occurred since the Unmanned Retail Strategy was first announced and the stock remains inexpensive relative to its growth potential and to category leading global peers,” Gonzalez wrote in a note to clients.

While the analyst believes that the company’s plan to introduce things such as vending machines is a good one, I see it as a classic case of a growing business trying to do too much to justify its heady valuation. 

If Luckin — with just two years under its belt compared to 21 years for Starbucks, thinks that it is going to out-execute Starbucks in China, it is sadly mistaken.

Furthermore, it just might turn out that the Chinese have a finer coffee palette than people realize. If this is true, they won’t be nearly as excited about convenient coffee in vending machines, but more interested in coffee that tastes good. 

The Bottom Line on LK Stock

On a non-GAAP basis, Luckin had an operating loss of $237.3 million in the first nine months of fiscal 2019. In addition, the company reported revenues of $409.8 million for that same period. That means for every dollar of revenue, it lost 58 cents. 

I fail to see how expanding to 10,000 stores while also expanding into vending machines is going to make it any easier for the company to make money. The capital required to pull off both of these moves is substantial. 

That said, while the capital it will have to spend to fund this expansion is real, there is no guarantee that profits will go along for the ride. 

Nonetheless, I did say in early January that I would give Luckin Coffee the benefit of the doubt in 2020. While I believe the coronavirus might not be Luckin’s only concern, LK stock is a lot more reasonable than it was three weeks ago.

I probably wouldn’t buy it. However, assuming the coronavirus plays itself out by March, $40 is a good entry point on LK stock.

At the time of this writing Will Ashworth did not hold a position in any of the aforementioned securities.


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