If you’ve followed Luckin Coffee’s (NYSE:LK) story over the past year, you know that LK stock dived in February on allegations of fraud by an unattributed source that short-seller Muddy Waters retweeted.
Already, class action lawsuits have been filed in the U.S. alleging that the Chinese coffee company inflated its financial performance starting in 2019’s third quarter. Luckin responded to the allegations calling them baseless, suggesting that the methodology used was flawed.
InvestorPlace’s David Moadel touched on the subject in early March, so I won’t get into it any further, except to say that the controversy puts a damper on one of the market’s biggest growth stories. That said, it’s prudent to apply a standard of “innocent until proven guilty” here.
However, comparing the performance of LK stock to Starbucks (NASDAQ:SBUX) over the past three months — Luckin is up 6.8% versus a 21.2% decline for Starbucks — it’s easy to see why CNBC’s Jim Cramer prefers Starbucks.
“Well you’re rolling the dice with Luckin. We got a lot of dice rollers. I don’t mind that at all because in the end you’re allowed to speculate. But I do think that if you like a coffee company, you ought to buy the one that my charitable trust has been buying, and that would be Starbucks,” Cramer said March 4 on Mad Money.
In February, I suggested that Luckin Coffee’s competition in China was going to intensify over the next 6-12 months, making the coronavirus just one of its major concerns as it works to push Starbucks aside.
I finished by saying I wouldn’t buy LK stock, but assuming the coronavirus played itself out by the end of March, under $40 was a good entry point.
Now that I’ve seen how much Starbucks has been punished over the past three months compared to Luckin, I’m inclined to agree with Cramer that SBUX is the better buy.
A Flight to Quality
If you’re going to buy stocks in this kind of market, you ought to buy quality rather than hoping for home runs. It’s no time to be too greedy, although Warren Buffett would argue a little never hurt.
The simple fact is that Luckin is trading for more than 16 times sales despite losing ground in the past month. Meanwhile, Starbucks is selling for a little more than three times sales. It’s dropped so much the company’s dividend is yielding a respectable 2.4%.
This morning, I went to my local Starbucks here in Halifax and noticed that the seating had been taken out. While open, until further notice, there will only be grab-and-go service. The whole world is shutting down, so it wasn’t unexpected. The same is happening at Starbucks in the U.S.
I will continue to visit my local Starbucks even if it’s take-out only. I’m sure it will see reduced revenue as a result, but that goes for most coffee shops in North America. It is what it is.
Over in China, where some investors are betting on Luckin overtaking the mighty Starbucks, SBUX announced March 13 that it is spending $130 million on a state-of-art roasting facility that will open in 2022 as part of its coffee innovation park (CIP). The CIP will have the largest roasting capacity outside the U.S. This new roastery will help support the 6,000 stores it will have open by 2022.
Still don’t think it’s serious about China?
Sure, it might not be 10,000 stores, like Luckin wants to hit by 2021, but it’s a significant number for a company that only ramped up its Chinese efforts a few years ago.
When Starbucks commits to a market, it takes no prisoners. It will not be pushed aside as quickly as some investors believe.
The Bottom Line on LK Stock
While I get the attraction of Luckin Coffee, I see the Chinese market completely accepting the Starbucks brand.
Much like what happened in North America a decade or two ago, the Chinese will flock to Starbucks because it represents quality. If you’re going to consider a coffee stock at this time, I see SBUX as the quality buy.
Will Ashworth has written about investments full-time since 2008. Publications where he’s appeared include InvestorPlace, The Motley Fool Canada, Investopedia, Kiplinger, and several others in both the U.S. and Canada. He particularly enjoys creating model portfolios that stand the test of time. He lives in Halifax, Nova Scotia. At the time of this writing Will Ashworth did not hold a position in any of the aforementioned securities.