[Editor’s note: This story was written prior to the news that Luckin Coffee allegedly fabricated its sales. Given these allegations, all investors should approach this stock with great caution.]
Only two questions really matter for Luckin Coffee (NASDAQ:LK). Can Luckin outgrow Starbucks (NASDAQ:SBUX) in China? If so, what is LK stock worth in that bullish scenario? Everything else is just noise.
Luckin has dealt with a lot of noise of late. The spread of the coronavirus in China has led to store closures which will dent the company’s sales and profits for at least the first quarter of 2020. A short-seller report drove panic selling as well.
But investors shouldn’t focus on short-term issues at the expense of the long-term trend. The trend promises potentially enormous returns for Luckin Coffee shareholders. All those issues have done is create a more attractive entry point.
Luckin Coffee Soars — And Tumbles
Just a few weeks ago, LK stock was one of the market’s best performers. Thanks in part to a blowout third-quarter earnings report in November, shares rose almost 200% in a little over two months.
Two developments ended the rally. Coronavirus fears rattled global stocks, and took LK down with them.
To add to the panic, Muddy Waters Research, via Twitter (NYSE:TWTR), linked to an anonymous report alleging that Luckin had fraudulently inflated its numbers. The 89-page report claimed to rest on video of 620 Luckin stores across China. Those tests suggested that the number of items sold per day was overstated by 69% in the third quarter of 2019. The report alleged pricing inflation as well.
LK stock plunged over 10% that day, capping a 35% decline in just nine trading sessions.
The problem with the selloff is that neither issue changes the long-term case for Luckin.
Luckin is going toe-to-toe with Starbucks in the world’s most populated country — and winning. Luckin now has more stores in the country than does Starbucks. It’s growing faster than its U.S. rival. And its model of often-unmanned stores and app-focused checkout procedures both suggest operating profit margins at maturity should be quite attractive.
The long-term opportunity here is why investors bid Luckin up so sharply after the third-quarter report. Early results show that Luckin is succeeding in shifting Chinese customers away from tea to coffee — and keeping those customers away from Starbucks. The company has plans to add thousands more stores to attract hundreds of millions more customers. And thanks to a convertible bond and stock offering last month, it has the capital to do so.
Neither piece of short-term news impacts that long-term bull case. The spread of the coronavirus will be contained at some point. The short-seller report looks questionable.
In fact, Citron Research, well-known for shorting the likes of Shopify (NYSE:SHOP) and Bausch Health (NYSE:BHC), has said it is long LK stock. The report “will fall short on accuracy,” Citron wrote last week. The firm added that it expected Luckin’s management to respond.
Management did respond this week, and flatly denied the report. Investors listened. Luckin stock soared 15.6% in trading on Tuesday.
The Long-Term Case for LK Stock
That rally should continue as the short-term fears fade. From a long-term standpoint, LK stock still looks reasonably cheap.
Admittedly, the company isn’t profitable. But that’s no surprise. Upfront spending to acquire new customers and to build out new stores is leading to near-term losses. But there’s a clear path for Luckin to grow into a nicely profitable business. As long as that path continues, LK stock can rise as have so many other growth stocks in this market.
Looking at revenue, the stock already doesn’t appear that expensive. Luckin stock trades for a little over 5x Wall Street’s estimate for 2020 sales. SBUX trades for roughly 4x revenue. Surely, investors should pay a modest premium for a substantially greater growth opportunity. Starbucks’ core markets in the U.S. and Europe are largely saturated. Luckin has no such problem in China.
As long as Luckin’s opportunity remains intact, and the company executes, LK stock can keep gaining. The noise that drove recent volatility is meaningless in that context. Some investors took the selloff as a buying opportunity on Tuesday. I expect more will do so going forward.
Matthew McCall left Wall Street to actually help investors — by getting them into the world’s biggest, most revolutionary trends BEFORE anyone else. The power of being “first” gave Matt’s readers the chance to bank +2,438% in Stamps.com (STMP), +1,523% in Ulta Beauty (ULTA) and +1,044% in Tesla (TSLA), just to name a few. Click here to see what Matt has up his sleeve now. Matt does not directly own the aforementioned securities.