Luckin Coffee (NASDAQ:LK) has not been trading since April 11. And when it does resume trading, there’s a fair chance that LK stock may go straight to zero. That may make the rest of this article moot. But analyzing stocks is what we do. So, whether you’re bullish or bearish on Luckin’s prospects, let’s assume the stock continues to go forward as a publicly traded company.
To me, that’s the fundamental question. The company is enduring a scandal that may well destroy the company. But the problem as I see is the company was already well on its way to a rough future.
Art Imitates Life…Which Imitates Art
By now, you’re familiar with the allegations against Luckin Coffee. COO Jian Liu and several of his direct reports are accused of creating fake transactions totaling $310 million. That would take away most of the $410 million of sales that the company reported at the end of Sep. 2019. And that would call into question the company’s losses which would be much larger than the $250 million loss that the company reported.
Sadly, the first place my mind went when I heard about the fraud was The Office. In one of the show’s many satirical situations, a character is convicted of committing fraud by double counting sales.
Of course, The Office is a comedy so everybody can see the fraud happening long before the character is arrested. The same can’t be said for Luckin Coffee shareholders. But there were warning signs. As I pointed out when I wrote about LK stock in March, the company did not disclose their number of active monthly users in their most recent conference call.
However this situation plays out, Luckin will be on a short leash with analysts and shareholders. And the reality is that investors may decide to pull the plug on Luckin stock.
Grab-and-Go Does Not Equal a Moat
The meteoric rise of Luckin brought attention to the company’s business model. Instead of building coffee shops that encourage customer interaction, Luckin’s model allows customers to simply grab their coffee and go about their day.
The strategy was to get market share through scale and speed. It was a model that allowed Luckin to have 4,507 location by the end of 2019, exceeding Starbucks (NASDAQ:SBUX) which has opened over 4,200 stores.
I’m not against the model. In fact, in the wake of the Covid-19 pandemic, a business model that intentionally enforces social distancing may work very well. But as I wrote back in March, it’s not a moat. And Starbucks is already looking at the Luckin model and testing its validity.
And Starbucks won’t be the only one. Which means that at some point, Luckin will have to raise its pricing model. The initial strategy of winning with scale and speed is going to be a flawed strategy if the customer has other options that offer the same speed.
It’s a simple calculation. It’s much easier for a company like Starbucks to copy Luckin’s model than it would be for Luckin to copy Starbuck’s model. And even if Luckin can fend off Starbuck’s for supremacy in China, the knowledge that Starbucks is gaining will allow it to effectively shut out Luckin from entering into the United States.
LK Stock Has Too Many Issues
David Moadel threw bullish investors a ray of hope. The company is cooperating with investigators and its stores are open. And Moadel makes the argument that a cup of joe is, after all, just a cup of joe. And the Chinese consumer, who is new to the coffee culture, may not discern one cup from another.
But that strategy cuts both ways. Which is why ride-hailing companies like Uber (NYSE:UBER) and Lyft (NASDAQ:LYFT) are finding it hard to gain dominance. But that seems to be the model that Luckin is based on. In fact, many of the company’s founders came from the Chinese ride hailing company Ucar.
The ride-hailing model is proving that you can have an app for just about anything. However, playing on price is a zero-sum game. And at this point, it’s a game that Luckin doesn’t look like they can win.
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. As of this writing, Chris Markoch did not hold a position in any of the aforementioned securities.
