Before the accounting scandal that led to the company’s fall from grace, Luckin Coffee (OTCMKTS:LKNCY) was a thorn in the side of Starbucks (NASDAQ:SBUX). The company’s combination of rapid expansion and low-cost offerings earned it the moniker “the Starbucks of China.” As much as I loathe lazy comparisons for clicks, it was fair to say Luckin was creating a niche. And that was good news for investors in Luckin stock.
In mid-January, Luckin stock was trading at over $50 per share. That was a 150% gain in just six months. In that same time period, Starbucks stock hardly moved. And part of the reason was that the company realized Luckin was carving out a troublesome niche.
The problem for Luckin was the niche relied heavily on promotion. This meant discounting its product, and in many cases giving the product away for free. Basic marketing tells you that when you start giving away your product for free, it starts to have a value. And that’s not good. Nevertheless, who’s to say what would have been before investors found out that Luckin was counting vouchers as sales.
But what it tells me is that it may not be easy for Luckin to achieve the growth it wants by simply raising the price. After all, there was a reason the company was getting their legitimate sales. And it wasn’t because people realized they loved the company’s coffee.
Starbucks Is Getting Smarter
Starbucks is using Luckin’s misfortune to fix some problems in its own business model.
The company has had a presence in China for years, but it has not enjoyed the same “if you build it they will come” success it had in the United States. Sure enough, Starbucks looked at Luckin’s model and realized that it needed to up its digital game.
And so it did. In its most recent quarter, Starbucks mobile orders accounted for 23% of sales. That was not just a post-pandemic boost. It was a significant increase from the mid-teen number that the company was recording before the pandemic hit.
Starbucks also launched a WeChat Mini program while enhancing its Starbucks Rewards program with a multi-tier redemption system that more closely approximates the system in the United States.
The bottom line is that Starbucks is beginning to look a lot like Luckin Coffee. Now as the saying goes, the ball is in Luckin’s court.
Luckin Stock Has to Thread a Difficult Needle
Luckin is pledging to be profitable in 2021. To do that will require, among other things, raising the price of its product. This is where it’s important to remember that part of Luckin’s success was due to its heavy promotion. The question now is just how much customers were attracted to the company’s low price.
This is to say nothing of the fact that the company isn’t completely out of the regulatory woodshed. As Josh Enomoto writes, the company’s fortunes may depend, in part, on the outcome of the United States presidential election. A favorable outcome for President Trump would certainly be a negative catalyst for U.S.-China relations. And it would be a near certainty that Luckin stock would be delisted from U.S. exchanges.
Luckin Needs More Than Survival
None of this is to say that Luckin Coffee can’t recover. Nio (NYSE:NIO) is a good example of a company that has had new life once the Chinese government intervened to ensure that solvency was no longer an issue.
However, Nio is leaning into an industry that is in high demand in China. As I’ve written before, Luckin Coffee is trying to create demand not only against the competition, but in opposition to the Chinese tea culture.
Luckin achieved its large customer base at a significant cost to cash flow. The company was burning cash before the scandal and now has to manage to raise prices while it convinces investors that its accounting scandal is behind it.
That would be a difficult pivot without a sleeping giant that is now wide awake. Luckin stock is a no for me.
On the date of publication Chris Markoch did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Chris Markoch is a freelance financial copywriter who has been covering the market for over six years. He has been writing for Investor Place since 2019.