A Long and Winding Road for Luckin Coffee

Luckin Coffee (OTCMKTS:LKNCY) has had quite the year so far. Once touted as China’s answer to Starbucks (NASDAQ:SBUX), Luckin has been at the center of perhaps the largest Chinese fraud. The $300 million accounting fraud led to Luckin stock losing 74% of its value this year and its listing on the Nasdaq. However, with a few changes at the top and a strategic shift, the company is on the path of rebuilding itself.

Luckin (LKNCY) logo on the wall of a coffee shop with a customer sitting at a table below it.
Source: abolukbas / Shutterstock.com

Unfortunately for Luckin’s investors, its legal woes are far from over. Recently, the Chinese State Administration concluded its investigation on Luckin’s fraudulent activities, slapping a $9 million fine. Additionally, the company faces class-action lawsuits from some of its investors. Assuming the lawsuits recover 4% of the company’s $1.2 billion valuation, it would cost the company around $48 million. Add the company’s dwindling cash balance, and you have the perfect recipe for disaster.

Hence, with so many risks, investors need to let things play out before thinking about Luckin stock again.

Let’s now take a closer look at some of these details.

Worrying Liquidity Position

One of Luckin’s main challenges is managing its cash burn, which continues to erode its cash balance. In the third quarter last year, it had $632 million in cash and raised another $865 million in January. That adds up to approximately $1.5 billion. However, it reported that its cash balance was at $780 million in June, burning more than $700 million in nine months.

The company is working to reduce cash burn and ensure it is profitable by next year. In doing so, it is cutting capital expenditures, advertising and other costs. Hence, its goal is to achieve profitability with existing stores rather than its previous strategy of expansion.

However, another problem for Luckin is its $460 million convertible notes, adding to the company’s debt burden.

Positive Changes

Luckin is making some positive changes of late in hopes of regaining its once famed position.

One of the things the company did poorly after admitting to the fraud was its executive changes. Soon after the fraud investigations started internally, Luckin’s co-founder Charles Lu was ousted from the board. Still, Lu was instrumental in the subsequent appointments of directors who were to replace him. However, with three independent directors’ recent appointments, it seems that Lu’s influence is fading fast.

The good news is that Sean Shao is back on the board as an independent director after being ousted by Lu. Shao played an integral role in pushing for an independent investigation on the company’s accounting fraud.  Moreover, Cao Wenbao and Wu Gang were also appointed as independent management directors. These appointments were facilitated by Centurium Capital, a key investor.

What’s most even more encouraging is management’s plan to increase productivity and margins from its existing store base.

I wrote a few months back about how the company’s attempts to ape Starbucks are likely to go in vain. The primary reason was Luckin’s flawed business model of increasing store count. On the flip side, Starbucks provides a luxury away from home, offering a complete package of excellent service, coffee and ambiance. It appears that Luckin executives understand their plight and are looking to cut down on advertising costs by store count. The management now aims to become profitable by 2021 through effective cost control and increased productivity.

Final Word on Luckin Stock

Luckin is getting its house in order in hopes of mounting a comeback. Its recent executive changes and transformed business model are encouraging for its investors.

However, there are some major risks that cannot be overlooked. The company’s plummeting cash balance, impending lawsuits and worrying debt position are some of them.

Hence, investors would need a lot more clarity before they could give Luckin stock another shot.

On the date of publication, Muslim Farooque did not have (either directly or indirectly) any positions in the securities mentioned in this article.

Muslim Farooque is a keen investor and an optimist at heart. A life-long gamer and tech enthusiast, he has a particular affinity for analyzing technology stocks. Muslim holds a bachelor’s of science degree in applied accounting from Oxford Brookes University.

Article printed from InvestorPlace Media, https://investorplace.com/2020/10/its-a-long-and-winding-road-ahead-for-luckin-stock/.

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