[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.]
Many know China as a nation of tea-drinkers. But coffee consumption has begun to take off in the country, and so quite a number of investors have taken an interest in shares of Luckin Coffee (NASDAQ:LK).
On its first day of trading in May 2019, LK stock opened at $25. The share price hit an all-time high of $50.38 in mid-January.
However, year-to-date LK stock is down over 38%. And the shares are now hovering around $24. Let’s take a look at the short- and long-term outlook for this coffee chain.
Q3 Results Showed Growth
Luckin Coffee was founded in 2017. In less than three years, it has grown from a single trial store in Beijing to over 4,500 stores.
On Nov. 13, 2019, the company released earnings for the third quarter ended Sep. 30, 2019. Investors were overall pleased with the results.
The Street had expected a 37 cents-per-share loss on expected revenues of $211.46 million. Instead, losses narrowed to 32 cents per share on revenue of $215.7 million. The revenue meant a YoY increase of 540% in local currency.
Average total net revenues from products per store in the quarter also jumped 79.5% YoY to reach $62,900.
Management believes that it will be able to leverage “big data analytics and AI to analyze the huge volume of data generated from … operations [to] continuously improve [its] systems.”
The group has not yet announced when Q4 results will be released. U.S.-based, publicly traded companies are required to file their quarterly 10-Q within 45 days of the end of quarter. But in the U.S., LK stock is traded through American Depositary Receipts (ADR). So the filing requirement does not apply to the company.
If you don’t already hold LK stock, you may want to wait for the release of Q4 results before you buy.
Consumer Trends Provide Long-Term Tailwinds
In November, co-founder and chairman Charles Lu highlighted that “China’s coffee market is still under-penetrated.” And he believes that “Luckin is helping to drive the rapid growth of the coffee market in China.”
Starbucks (NASDAQ:SBUX) entered China in 1999. The global chain now has “4,200 stores in 177 cities in mainland China, employing over 57,000 partners.” Starbucks charges around $5-equivalent in local currency for a cup of coffee — an amount still considered quite high for the average Chinese consumer.
In less than three years, Luckin Coffee has become a key competitor to the U.S.-based coffee giant. However, unlike Starbucks which emphasizes the “in-store coffee experience,” Luckin Coffee has a buy-online-through-the-app, pick-up-in-store business model.
According to recent research by Singapore Management University, the group offers “lower prices and the convenience of having coffee anywhere, appeal[ing] to the country’s digitally savvy millennials.” Its stores, which do not have cashiers, rely on technology and offer limited seating.
In other words, management’s focus on takeaway is a differentiator for LK. And as long as the coffee consumption trend in China increases, the coffee chain is likely to keep growing.
The COVID-19 outbreak which started in early 2020 in China has now become a global pandemic. And investors have for the most part been stampeding out of broader markets. Yet, if you too believe that Luckin Coffee operates in a segment that is positioned to grow for years to come, then you may decide to ignore the current short-run disruptions and buy LK stock for the long-term.
What Could Derail LK Stock Short-Term?
Fraud Accusations: In late January, short-seller Muddy Waters released a report accusing Luckin Management of fraud. It also said the group had a “fundamentally broken business.” InvestorPlace’s David Moadel wrote a detailed article on these developments earlier in the month.
Later in February, when LK’s management denied any wrongdoing, Needham analyst Vincent Yu raised its price target on Luckin from $27 to $40.
However, in the coming weeks, if there are any further such adverse issues, then LK stock price will likely suffer again.
Burning Through Cash
Like many startups, Luckin has incurred heavy losses. Although the company is growing fast, it is also going through significant amounts of cash.
With the expansion of stores, the number of employees is increasing. Marketing expenses are on the rise, too. Furthermore, it has recently launched Luckin Tea and is working to develop a Luckin Juice business. All these initiatives require substantial investments.
In other words, management will need to show the Street how and when it will likely become profitable. Otherwise, quite a number of investors may decide to throw in the towel, especially if there is an economic slowdown in the coming months.
Short-term Technical Charts
Are you an investor who also pays attention to technical charts? If yes, then the recent market price action suggest that LK stock may fall some more.
In case of further weakness in broader markets LK stock price could easily move toward $19. Understandably, any company-specific adverse news would also bring the Luckin bears out.
Even if such a decline does not happen in the coming weeks, the shares would need to build a base before a new sustained leg up can happen.
Bottom Line on LK Stock?
I regard Luckin Coffee, often referred to as the “Starbucks of China,” as a promising company for investors looking to capitalize on China’s growing number of coffee drinkers.
However, the current global nervousness over the potential economic effects of the coronavirus outbreak requires caution. Thus, I’d prefer to wait before committing any new capital to LK stock — at least until its upcoming Q4 results are made public.
At the time, management should also be able to answer any further questions regarding the recent fraud allegations. Such rumors would need to be fully put to rest. Otherwise, the stock cannot start a sustained rally again.
Tezcan Gecgil has worked in investment management for over two decades in the U.S. and U.K. In addition to formal higher education in the field, she has also completed all 3 levels of the Chartered Market Technician (CMT) examination. Her passion is for options trading based on technical analysis of fundamentally strong companies. She especially enjoys setting up weekly covered calls for income generation. As of this writing, Tezcan Gecgil did not hold a position in any of the aforementioned securities.