It’s LK Stock’s Business Model That’s the Problem

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It’s not really a surprise that LK stock (NYSE:LK) is being rewarded by investors. The company embraces a data-driven model in an era where analytics is a coin of the realm. This focus on data has fueled the company’s meteoric rise in China.

Ignore the Noise, Buy the Opportunity Percolating in Luckin Coffee

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It also has investors convinced that LK stock can continue to grow even as China continues to recover from the effects of the coronavirus.

Luckin embraces a “grab-and-go” model that has allowed the company to open over 4,500 stores in China. The idea is surprisingly simple, consumers order via an app, they are directed to the Luckin Coffee location near them, they pick up their coffee and go on their way.

Whereas Starbucks (NASDAQ:SBUX) has based their primary model on the idea of social interaction, Luckin is taking the opposite approach. People want their coffee, the social interaction not so much.

“Starbucks’s strategy is based on real estate whereas Luckin is based on smartphones,” said Jeffrey Towson, professor of investment at Peking University Guanghua School of Management. This digital first strategy, in theory, should help Luckin expand faster by saving on operational costs.

With present concerns about social distancing, that may be appealing, but I see a couple of challenges for the long-term growth of Luckin Coffee.

China is New to the Coffee Culture

Luckin Coffee is building a base of coffee drinkers in a nation of non-coffee drinkers. That has to be counted in their favor. And the company seems to be targeting and attracting a younger customer base to which this may actually catch on. However it’s taken Starbucks 20 years to build a presence in China, and the country is still not a nation of coffee drinkers. There’s a difference between sampling a product and making that product a regular part of your daily routine. Which brings me to my second concern about investing in Luckin stock

Free Always Has a Value

The business model of Luckin is about bringing in users through the app. When a customer signs up, they get their first coffee free. After that they receive multiple coupons and offers all geared towards getting repeat customers. Here’s the problem.

In the first quarter of 2019, Luckin had a net loss of 551.8 million yuan after generating net income of 478.5 yuan. The spread was even worse for the full year of 2018 (revenue of 840.7 million yuan with a net loss of 1.619 billion yuan).

Wang Quinglin, an analysts at iiMedia Research suggests that the discount model that allows Luckin to attract customers may also turn into its downfall. Investors will be paying attention to Luckin’s active monthly user numbers. From August 2018 through the first quarter of 2019, the active monthly users on the app remained steady at 400,000. In their most recent conference call, the number of active monthly users was not addressed. Although the company is showing increasing revenue, investors should pay close attention to the demand side before making a decision.

Let the Buyer Beware with LK Stock

With nascent companies like Luckin Coffee, you have to have conviction. My conviction at the moment is that the brand does not have a moat. Critics will point out that Luckin has delivered growth that it took Starbucks 20 years to reach. But the models are different.

And there’s evidence that Starbucks is now adapting their model to better compete with Luckin. And here’s what you need to be aware of. There’s nothing to stop them. The model is effective, but not proprietary. In fact, Starbucks is already copying the model to determine its viability.

I’ve seen some skeptics compare it to ride-hailing companies like Uber (NYSE:UBER) and Lyft (NASDAQ:LYFT). In fact many of the company’s founders came from the ride hailing platform Ucar. After their meteoric initial launch, the companies have yet to become profitable. The same risk exists for Luckin Coffee. Getting customers to try the product will not be enough.

And as Tyler Craig pointed out in a recent InvestorPlace article, investors are expressing uncertainty about the stock’s direction.

But I’m less worried about the company’s ability to find customers, and far more concerned about its ability to protect its turf. There’s nothing stopping other companies from appropriating Luckin’s model. And that is not good news for LK stock.

As of this writing, Chris Markoch did not hold a position in any of the aforementioned securities.

Chris Markoch is a freelance financial copywriter who has been covering the market for over five years. He has been writing for InvestorPlace since 2019.


Article printed from InvestorPlace Media, https://investorplace.com/2020/03/lk-stock-business-model-may-be-problem/.

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