If anyone needs proof the markets have gotten overheated, Luckin Coffee (OTCMKTS:LKNCY) is a prime example. On July 1, the company admitted that it inflated sales by $300 million between the second and fourth quarters of 2019. Yet, Luckin stock continues to trade above $2.
I have a hard time understanding who exactly is investing in this broken company. I know I’m sure not. Nor are most of my InvestorPlace colleagues.
I’m entirely shocked it is still trading. I mean, if it has a legitimate business, why hasn’t someone in China offered to take it private? If found to be clear of any further wrongdoing, the company would be a bargain for some adventurous private equity outfit, who could rehab Luckin’s reputation outside the glaring lights of the public markets.
Alas, there are too many skeletons in Luckin’s closet to rise from the ashes.
Who Is Buying Luckin Stock?
My InvestorPlace colleague, Luke Lango, who is ranked numero uno out of 7,574 bloggers by TipRanks, believes the bull thesis for Luckin is still alive. I’m intrigued by Luke’s contrarian position. Perhaps Luke is channeling his best David Dreman, arguably one of the greatest contrarian investors of the last 100 years.
A recent article by Lango points out several situations where his contrarian take produced fabulous results — Blink Charging (NASDAQ:BLNK) up almost 800%, Workhorse Group (NASDAQ:WKHS) up nearly 800%, and Nio (NYSE:NIO) up more than 500% — and now he’s suggesting the same thing is about to happen to Luckin.
I never want to dismiss people who’ve got good track records, so let’s consider Luke’s thesis for the beleaguered coffee chain.
His three main arguments include sufficient liquidity, rising Chinese coffee demand, and a technology-driven business model. Forget the first two arguments. I want to focus on the technology-driven business model.
“Build small stores – typically 400 square feet – with limited to no seating space. Develop an app for mobile ordering. Have consumers order from the app ahead of time, and simply pick up their coffee in store,” Lango wrote on Aug. 17.
“Pass on the cost-savings from running smaller stores with less staff, to consumers, through lower priced coffee. Even open a few vending machines which sell ready-to-drink coffee products.
“It’s a genius business model. Young people are addicted to their phones. They don’t like to wait. And they are price conscious.”
To cement his argument, my colleague points out that Luckin’s sales rose 250% in 2019, excluding fraudulent growth.
It’s a compelling argument. It is. Maybe Robinhood’s younger investors are lapping up Luckin stock, understanding the contrarian growth angle.
Or maybe it’s a dead stock walking.
Bankruptcy Looms
InvestorPlace’s Thomas Yeung wrote an excellent piece about Luckin earlier in August that pokes some holes in the bullish argument. I recommend you read it.
Yeung argues that once company insiders and regulators take their cuts, the company will be left with very little to reward holders of American depositary shares.
“In its three short years, Luckin Coffee has burned through at least $778 million of investor money. And losses are accelerating from the company’s breakneck expansion. In Q3 2019 alone, the company purportedly lost $82 million with 3,680 stores,” Yeung wrote on Aug. 6.
“With 6,000 stores today, Luckin is likely burning through cash at an even faster rate.”
As Yeung points out, once the Chinese government is done with Luckin, it might be ready for the scrap heap. Contrarian view or not, bankruptcy is a reality for Luckin, which makes me wonder why its share price continues to trade above $2.
The last financial document investors received from Luckin was its secondary offering in January. It sold nine million ADS at $42 a share, generating net proceeds of $363.6 million from the offering. These funds will definitely help it fend off bankruptcy.
At the end of September, which includes $134 million of the $300 million in inflated sales, it had $631.5 million in cash. Add in the funds from the secondary offering and it would have had a little over a billion dollars heading into the fourth quarter, which produced $166 million in inflated sales.
In the first nine months, it had an operating loss of $252.9 million. Who knows what the legitimate loss was through the third quarter of 2019? As my colleague says, Luckin hasn’t released accurate financials for at least a year.
Investors have no idea what amount of cash is left in the kitty from this unbelievably brash act of fraud. Until we know that, I don’t see why you would take a risk on Luckin stock.
As I stated in July, when something is too good to be true, it probably is.
This is one contrarian play I don’t think is going to turn out okay for American shareholders.
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.
