This is the first time I’m writing about Luckin Coffee (NASDAQ:LK) since LK stock resumed public trading. This followed the stock falling under $1 in the wake of an accounting scandal. To sum it up in a simple fashion, Luckin gave away vouchers for coffee purchases, but they realized all of those credits as sales.
The first thing I thought of when I heard about this fraud was an episode of The Office. On the fictitious show, a character is arrested for double counting physical sales on the company’s nascent website. Of course, there’s a difference between comedy that’s specifically designed to cross the line of believability. It’s another thing altogether to have a scandal like this play out right before your eyes.
But let’s move forward. Luckin isn’t the first company to deal with a scandal like this. And sadly, it won’t be the last. So, it’s only fair to ask if the company can possibly recover to become a bargain basement stock.
The Fundamental Problem for Luckin Coffee
I wouldn’t count on it. Luckin’s fundamental problem is not just regaining their customers’ trust. It’s actually more fundamental than that.
China is not a coffee drinking country. In the United States, that may be hard to understand, but China does not have a coffee culture. According to research from the University of Southern California, per capita coffee consumption in China is just five cups a year. That’s not a misprint. In the U.S., per capita is 400 cups a year. And in some European countries that number can exceed 1,000 cups a year.
But the problem is as much about perception as it is about reality. Coffee is still considered a luxury item in China. As a result, it commands a higher price. So Luckin’s efforts to bring coffee to the masses still faces an uphill battle.
This Is a Problem Not Limited to Luckin
Starbucks (NASDAQ:SBUX) has been trying to make inroads, but was showing slowing same-store growth in China in early 2019, nearly a year before the Chinese economy was affected by the novel coronavirus. And this wasn’t a one-quarter trend. Starbucks had been dealing with slowing same-store growth in the country since 2017.
Some of this is slower growth is due to Starbucks employing the same strategy that led to the “Starbucks on every corner” growth in the United States. With a plan to have 4,125 stores open in China by the end of 2019, some cannibalization of sales was inevitable.
However, Starbucks also realized that any sustained success in China meant rethinking their business model. And that’s where the story becomes positive for Luckin. The upstart rival understood that the Chinese consumer preferred a “grab and go” model for getting their coffee. This allowed Luckin to expand quickly without necessarily having to build out physical infrastructure.
But the Chinese consumer has been slow to become addicted to coffee even though Luckin’s signature move is to lure customers in with a free coffee. And that is making it difficult for Luckin to raise prices.
Why LK Stock Is Not the Bargain It May Seem
On the one hand, I can understand why investors would be eager to buy shares of LK stock. The company is surviving an accounting scandal. And not just any accounting scandal, a fraud of counting sales that the company never made.
At this point, investors should have confidence in the company’s financial numbers. They couldn’t be that foolish again, could they? It’s not that I give Luckin a pass for fraud, but I believe they will be conservative in their numbers.
The real problem for Luckin stock is that they have a product that nobody really wants even when the company is giving it away. Is that evidence that Starbucks is capturing whatever coffee-drinking base exists in the country? Or is it proof that converting this market may not be as simple as expected?
Larry Ramer shows a plausible but narrow path for Luckin to thrive. Some of that plan relies on Luckin pivoting to being as much of a tea company as it is a coffee company. But that would require other changes. Because when your company’s name has coffee in it and stirring demand for coffee at a profitable price is a problem, then it’s not an investable business.
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.