Shares of disgraced Chinese chain Luckin Coffee (OTCMKTS:LKNCY) are building up remarkable steam this month. The company’s encouraging joint provisional liquidators’ (JPL) report and its settlement plans with the U.S. Securities and Exchange Commission (SEC) continue to boost Luckin stock.
In fact, the JPLs have reported a whole laundry list of actions they have taken in straightening out Luckin’s operations. It appears that the scandal-ridden coffee chain has a chance at redemption. However, you probably shouldn’t get your hopes up too much.
Perhaps a more pertinent element to examine for Luckin is its strategy, which has been flawed from the get-go. The company’s original goal was to pursue rapid expansion and continue to offer customers free cups of coffee in hopes of matching Starbucks (NASDAQ:SBUX). Now, though, LKNCY has shifted its focus from rampant expansion to targeted expansion in order to improve cash flows and profitability.
Under the new plan, Luckin will be closing its underperforming stores to sustain the long term. As of November last year, the company has reduced its store count from 4,507 to 3,898. Basically, Luckin is in a period of readjustment, but there are many other angles to the Luckin story that you need to consider before jumping on its bandwagon.
Luckin Stock and the SEC Settlement
Luckin stock was relegated to the pink sheets back in June of last year, after its financial scandal was exposed. However, last month, the company announced that it reached a settlement with the SEC to pay $180 million in penalties for the fraud. That payment can be offset by amounts paid to its convertible bondholders and shareholders.
On the settlement, the company’s new chairman and CEO, Jinyi Guo, remarked, “This settlement with the SEC reflects our cooperation and remediation efforts, and enables the Company to continue with the execution of its business strategy.” In that vein, the SEC also noted that Luckin fully cooperated during the investigation and swiftly made the necessary changes.
However, LKNCY has made some tall claims in its JPL report, stating that it would become cash-flow positive on a normalized basis in early 2023. Moreover, it also stated that it was profitable on the “store level” in August last year. Additionally, Luckin is also negotiating with its $460 million convertible debt holders.
Liquidity should be an issue, though, regardless of the company’s claims. For one, you have to factor in the cash burn, which was as high as $700 million from the fourth quarter of 2019 to Q2 of 2020. Covid-19 likely hasn’t helped in reducing that bleeding, either.
Can You Trust Management?
Right now, it appears that the SEC and JPLs feel that Luckin has seen the error of its ways and is approaching things with utmost sincerity. The company has even effectively distanced itself from the employees who committed the fraud.
However, the problem with that argument is that it absolves people like its ex-Chairman and founder Charles Zhengyao Lu. Unlike current management, Lu did not cooperate with the investigation and got two key directors of the investigation removed in a special meeting. He later got himself removed but green-lit the appointment of “two of his hand-picked successors.”
Therefore, Lu was able to get out of all these complications relatively unscathed. Moreover, he also kept his stake in the company. In such circumstances, how can investors afford to trust the numbers behind Luckin stock going forward?
Judging from the JPLs’ report and the SEC’s comments, it appears that Luckin’s redemption could become a reality soon. The company’s strategic shift towards targeted expansion and profitability is encouraging and could play a massive role in its potential recovery.
However, for me it’s tough to buy the story at this point — both because of the Lu situation and the lack of information regarding its financials. So, tread lightly if you’re thinking of investing in Luckin stock at this time.
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. He does not directly own the securities mentioned above.