After it was revealed that Chinese coffee startup Luckin Coffee (OTCMKTS:LKNCY) had been cooking its books, some started to consider the firm a value play, Luckin stock is down more than 90% since the start of April.
Perhaps the easiest way to make money on the stock market is through buying undervalued stocks. Bad news, an executive-level scandal, or anything that causes investors to jump ship from an otherwise strong company is the best time to scoop up quality companies at a discount, but Luckin stock is plagued by more than just an accounting scandal, making it a risky bet for long-term investors.
When you consider that companies like General Motors (NYSE:GM) knowingly killed hundreds of people with its faulty products and came back stronger than ever, buying a coffee company with accounting issues doesn’t sound quite so bad.
But there are a few differences between what happened at GM and what happened at Luckin that investors need to keep in mind.
The first, and arguably most important, is trust. When GM’s ignition switch issues came to light, consumers’ trust in the firm understandably declined. But from an investment standpoint, the firm had always been forthcoming about its financials and future direction. Its new CEO offered further confirmation that GM was going to turn things around.
Luckin Stock Comes With Trust Issues
At Luckin, that’s not really the case. While Luckin founder and Chairman Charles Lu has been voted off the board, he was also responsible for choosing its newest members. Many believe he’s still in charge of the company, and his behavior when the accounting fraud was discovered suggests he was somehow involved.
Plus, the company has yet to disclose its earnings. That means investors effectively have no idea how well Luckin has been doing. Back when we believed the quarterly results Luckin was releasing, it appeared there was a gap in the Chinese market for coffee delivery. You could make the case that Luckin’s app offers the company a unique data set that will make targeted advertising easier and that it’s technology-centered strategy appeals to young adults in China.
But now, without any real gage of how the firm is doing, it’s impossible to make those arguments with confidence.
If we could verify that Luckin’s business model was working in China, there would be far less risk in picking up Luckin stock. After all, the firm’s coffee-drinking customers don’t really care about the firm’s accounting policy, so once Luckin had appeased auditors it could return to growth.
Without knowing the business was thriving before the scandal, buying Luckin stock on recovery hopes is a gamble.
Luckin Has Other Risks
Even assuming that Luckin was gaining traction among tech-savvy coffee drinkers, there are still risks to the firm’s long-term growth story. For one, there’s a lot of competition in the coffee space. Starbucks (NASDAQ:SBUX) is also attempting to break into the Chinese market and the better-funded chain will make it difficult for a profit-less startup struggling with an accounting scandal to compete.
Not only that, but this is one of the worst times in history to be a startup that has yet to turn a profit. The economic damage caused by the novel coronavirus is yet to be determined and there could be another wave of new cases in the fall.
Even if Luckin’s previous figures had been true, operating in such uncertain times would have been a challenge. But considering the company’s finances are even tighter than they appeared, it’s a big undertaking.
There is a chance Luckin stock will make an impressive recovery over the next few months if everything goes right for the company. Investors who scoop up the stock now will be handsomely rewarded for sticking with the firm. But at this point, the case for Luckin is largely theoretical and for that reason, I wouldn’t be comfortable buying it, especially not in the current environment.
Laura Hoy has a finance degree from Duquesne University and has been writing about financial markets for the past eight years. Her work can be seen in a variety of publications including InvestorPlace, Benzinga, Yahoo Finance and CCN. As of this writing, she did not hold a position in any of the aforementioned securities.