China’s State Administrator for Market Regulation sent more than a dozen officers to Luckin Coffee’s (NASDAQ:LK) offices on April 26. The investigators took all kinds of company records to get to the bottom of the company’s fabrication of sales. Very quickly, LK stock has become an embarrassment for the Chinese government.
That makes many wonder, is it time to turn out the lights on Luckin Coffee? I think so. Here’s why.
Growth Is an Illusion
When Luckin’s story first came across my desk in June 2019, I couldn’t help but wonder how this out-of-nowhere story was able to open so many stores in such a short period. After all, I was a big believer in Starbucks (NASDAQ:SBUX) and what Seattle’s best were doing in China.
In June of last year, about a month after Luckin went public at $17 a share, I included Luckin on a list of seven first-half IPOs that would falter in the second half.
“Of all the IPO stocks on this list, Luckin is the one I’d be most wary of — primarily because it’s trying to steal … [Starbucks’] thunder in China,” I wrote on June 13, 2019. “Also, the coffee market in China continues to see new, larger entrants like Restaurant Brands International’s (NYSE:QSR) Tim Hortons and others, enter the scene, making it doubly hard for Luckin to become profitable.”
There’s that pathway to profitability problem, again. How inconvenient. Who knew the whole thing was going to blow up less than a year later. I sure didn’t. My stance on Luckin even softened slightly entering 2020.
“Needless to say, the Luckin story has been a good learning exercise for me. It’s taught me that sometimes the story is just as they say it is. Sometimes it’s not too good to be true. Luckin’s success in 2019 also doesn’t mean the coffee chain’s best days are behind it,” I wrote on Jan. 9.
I finished the article by stating I would give Luckin more credit in 2020, ultimately hoping that it wouldn’t let me down. It did.
However, given it didn’t make money and was going up against Starbucks, there is no way I would have ever recommended Luckin stock to anybody but the most aggressive and speculative of investors.
That said, it’s disappointing the story has been such a letdown. This won’t do wonders for China’s image on the world stage. Of course, North American companies also offer investors plenty of shady opportunities. This isn’t a Chinese thing; it’s a greed thing. If you look hard enough, you’ll be sure to find trouble.
How Did the CEO Not Know?
The Luckin company line is that it is “actively cooperating” with the market regulator and other related authorities.
On April 2, when Luckin announced it was setting up an independent special committee to oversee an investigation of the alleged fraud, it was quick to point out who the culprits were.
“The Special Committee today brought to the attention of the Board information indicating that, beginning in the second quarter of 2019, Mr. Jian Liu, the chief operating officer and a director of the Company, and several employees reporting to him, had engaged in certain misconduct, including fabricating certain transactions,” stated Luckin’s April 2 press release. “The Special Committee recommended certain interim remedial measures, including the suspension of Mr. Jian Liu and such employees implicated in the misconduct.”
Sure, the company apologized for the embarrassment the scandal brought upon all of Luckin’s stakeholders. Still, unless I’ve missed something, it doesn’t appear as though either Chairman Lu Zhengyao or CEO Qian Zhiya, who combined hold more than 60% of the votes, have shown zero remorse for what’s happened on their watch.
I find it impossible to imagine that both the CEO and Chairman did not have some idea of what was going on at Luckin. The fact that their hands aren’t all over the documents in question does not make them innocent parties. The same goes for the board.
Technode’s Michael Norris feels the same way.
“All this makes it hard to believe that COO Liu Jian would commit fraud without the actual or constructive knowledge [of] Chairman Lu Zhengyao, CEO Qian Zhiya and CFO Reinout Hendrik Schakel,” Norris wrote April 8. “My present hypothesis is that Liu, as a long time errand boy for Chairman Lu Zhengyao, has taken the fall to buy time for Luckin’s management to work out their next move following a quarter rocked by an extended Chinese New Year and COVID-19.”
Norris goes on to argue the case for a turnaround, one without either the Chairman or CEO running the business. In theory, it makes sense.
The Bottom Line on LK Stock
Fool me once, shame on you. Fool me twice, shame on me.
While Norris makes a compelling argument about how Luckin can successfully right the ship, I just don’t think this particular group of insiders are capable of engendering the kind of trust required to keep investors onboard.
If Luckin burnt you, the best thing you can do is chalk it up to experience and move on with your life. This situation isn’t going to get better anytime soon.
It’s time to turn out the lights on LK stock.
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.