Luckin (OTCMKTS:LKNCY) stock is up 152% in one month, leading to renewed interest in the scandal-ridden Chinese coffeehouse chain. However, investors that value fundamentals should steer clear of Luckin stock.
Despite positive sales momentum and a settlement with the U.S. Securities and Exchange Commission (SEC), questions surrounding the business’s future persist.
As they say, once bitten, twice shy. InvestorPlace‘s Matt McCall argued that “until the company resumes releasing financial information quarterly, high skepticism will continue.” I believe that’s a very valid point. Peaks and valleys are expected with this one, considering Luckin stock remains a favorite for Robinhood app traders.
However, it’s too early to buy this comeback story.
Luckin Stock: Finally, Some Good News
Luckin shareholders hoping for respite this year finally got what they were waiting for. U.S. regulators slapped a fine of $180 million on the Chinese coffee chain in announcing a settlement with the company on Dec. 16.
That may seem stiff, but it’s more of a slap on the wrist. Unrestricted cash and cash equivalents and short-term investments stood at $742.7 million as of Nov. 30. These proceedings come in the wake of a stunning accounting scandal that no one saw coming.
According to the SEC, Luckin intentionally fabricated over $300 million in sales from at least April 2019 through January 2020. Certain employees created a fake operations database and altered bank records to reflect fraudulent sales.
However, the house of cards fell when short-seller Muddy Waters published an 89-page report, leveling allegations that the company is fabricating its financial and operating figures, beginning with Q3 2019. Its business in the U.S. and China fell into disarray. Nasdaq delisted Luckin stock because of “public interest concerns,” and shares wound up on the pink sheets.
Over the last couple of months, though, we see renewed interest in the stock. Markets are optimistic that the company can mount a comeback now that its legal battles stand settled. The report submitted to the Grand Court of the Cayman Islands has several positive beats pointing towards a slow recovery.
But as InvestorPlace‘s Divya Premkumar points out, the accounting scam will continue to hang over its reputation for a long time to come.
Picking Up the Pieces
It’s important to give credit where it’s due. If you had asked me six months ago whether there was any chance of recovery for Luckin stock, I would have said the odds are against it. However, as it stands, the company is in much better shape than expected.
According to the strategic plan laid out in the Joint Provisional Liquidators’ first report, the number of Luckin Coffee stores is down to 3,898 from 4,507, including 894 affiliated stores, greatly reducing the pressure coming from nonprofitable stores. Plans are for Luckin to operate 4,800 to 6,900 coffee shops by 2023 eventually.
Despite the pandemic, the company managed to show sustained growth throughout the first three quarters of 2020. Luckin is projecting between 3.8 billion yuan and 4.2 billion yuan in sales for the fiscal year 2020. After some much-needed retooling, 60% of Luckin’s stores have achieved profitability.
Although it’s unlikely that the company will be competing with Starbucks (NASDAQ:SBUX) for China’s coffee crown any time soon, I would say it is in better shape than it was at the height of this crisis. Many expected the company to fade away. The fact that it’s still there and showing signs of life is a blessing in and of itself.
Luckin Has Become a Test Case
Regulators are taking a tougher stance when it comes to Chinese companies. Two accounting scandals involving TAL Education Group (NYSE:TAL) and the other involving Luckin Coffee have led to people questioning China’s corporate governance environment. The fallout from these scandals affects other Chinese companies and has only added to skepticism among overseas investors.
It has also had a knock-on effect in terms of legislation. President Donald Trump recently signed the “Holding Foreign Companies Accountable Act,” legislation that could remove Chinese companies from U.S. exchanges if American regulators cannot review their financial audits.
These days, Democrats and Republicans don’t seem to agree on anything. Hence, it’s pretty amazing that the bill passed both the U.S. Senate and the House of Representatives with unanimous support, clearly indicating how anti-Beijing legislation has brought Democratic and Republican lawmakers together when they can’t seem to agree on anything else.
It pretty much goes without saying that a major reason why this legislation got through so quickly was because of scandals like Luckin.
Not a Winner Yet
In conclusion, I would say that Luckin stock is in much better shape than it was a couple of months ago. Markets reflect that sentiment. However, there is still a long way to go. The reputational damage that it has suffered is leading to repercussions on a wider scale.
Having said that, I would keep my eye on the company for the foreseeable future. It keeps on digging out of an almost impossible hole.
On the date of publication, Faizan Farooque did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Faizan Farooque is a contributing author for InvestorPlace.com and numerous other financial sites. Faizan has several years of experience analyzing the stock market and was a former data journalist at S&P Global Market Intelligence. His passion is to help the average investor make more informed decisions regarding their portfolio.