Shares of disgraced Chinese coffee chain Luckin Coffee (OTCMKTS:LKNCY) soared Thursday after the company reported it had reached a settlement with the SEC for fabricating a big chunk of its 2019 sales. As of this writing, LKNCY stock is up more than 40% on the news.
This settlement is big news for LKNCY stock for two reasons:
First, it confirms that Luckin Coffee will survive its fabricated sales scandal. The SEC’s fine was a slap on the wrist. So was China’s fine back in September. In total, Luckin Coffee will have to pay less than $200 million in penalty damages — an amount that leaves the coffee chain operator with plenty of cash still left on its balance sheet to live to see another day.
Two, it’s clears the skies for Luckin Coffee to get back to business as usual. The U.S. and China have both levied their fines. Restructuring has already happened. Delisting has already happened. All is done. It’s time to close the book on this scandal, and open a new book of Luckin Coffee turning into a newer, better version of its former self.
Thus, the stage is set for Luckin Coffee to take its still-loaded balance sheet and invest those resources into recharging this hypergrowth narrative. As the company’s hypergrowth narrative is restored, Luckin stock will soar to $20.
Luckin Coffee Will Survive
One of the biggest concerns with respect to LKNCY has been that the company won’t survive its fabricated sales scandal. That is, many feared that huge fines from both the U.S. and China would drain Luckin Coffee of its resources, and force the once high-flying coffee chain to declare bankruptcy.
Those fears are proving to be dramatically overstated.
As it turns, neither the U.S. nor China brought the hammer down on Luckin. The Chinese State Administration for Market Regulation fined Luckin Coffee about $10 million. The SEC settled with the company for $180 million. Thus, in grand total, Luckin Coffee is shuffling out just $190 million for its fabricated sales scandal.
The company reported having $780 million in cash on its balance sheet as of late June. Take out $190 million for fines and penalties. That leaves the company with $590 million in cash.
Cash burn in the third quarter of 2019 — the last quarter for which we have numbers — was about $20 million, meaning that the $590 million Luckin Coffee still has left on the balance sheet is more than enough to keep the coffee chain’s doors open for a lot longer.
This reality that Luckin will live to fight another day is likely behind Luckin stock’s big rally.
Luckin Stock: Ready to Charge Back Into Hypergrowth Mode
Although survival is boosting LKNCY stock today, the opportunity for Luckin Coffee to thrive over the next few quarters will drive LKNCY far, far higher.
With a cash balance equal to roughly 29X its quarterly cash burn, Luckin Coffee has ample resources to invest back into the company. This includes opening new stores, upgrading existing stores, fleshing out the logistics networks, innovating on the menu and even pushing forward on its novel vending machine concept that had investors drooling back in early 2020.
In other words, Luckin Coffee has enough firepower left to charge itself back into hypergrowth mode.
It appears this is already happening. Going through China’s popular social media platform Weibo, it appears that Chinese consumers are posting about and drinking Luckin Coffee products more often than they ever have.
Luckin Coffee is back.
The company is now ready to honestly execute on its huge growth opportunity in turning China into a coffee-drinking nation, something which is bound to happen given demographic and globalization changes increasingly “westernizing” China’s young population. Luckin Coffee is also attractively positioned to lead this enormous pivot, because of the company’s technology-first, mobile-focused, small-format stores, which are designed to be placed in urban areas and to be used by young consumers.
If management executes on this huge opportunity, the long-term potential upside in LKNCY stock is enormous.
Huge Upside for Luckin Coffee Stock
My long-term thinking on Luckin Coffee has not changed in recent months. I’ve just grown more confident on the company’s ability to execute on its opportunity as fraud headwinds have passed.
This long-term thinking is predicated on a few basic assumptions:
- China’s coffee market is going to boom over the next few years as young, westernized Chinese consumers become the country’s big spenders.
- Luckin Coffee is going to leverage its small-format stores to be prevalently located throughout all major Asian cities, amounting to what I see as ~30,000 stores at scale.
- Luckin Coffee will simultaneously leverage its mobile-first sales model to keep those stores fairly busy, and will drive net sales per square foot to about half that of Starbucks (NASDAQ:SBUX).
- Operating margins will ultimately pan out at Luckin Coffee where they are at Starbucks, which is in the 15% to 20% range.
Under those assumptions, my modeling says that Luckin Coffee will do about $3 in earnings per share by 2030. Based on a 16X forward earnings multiple and a 10% annual discount rate, that implies a 2020 price target for LKNCY stock of $20.
Thus, at $5 today, I think Luckin Coffee stock still has a long ways to go before this rally is done.
Bottom Line on LKNCY Stock
I get why you wouldn’t want to touch Luckin Coffee stock with a nine foot pole. But — as the great Warren Buffett once said — sometimes it pays to greedy when others are fearful.
This is one of those situations.
The optics surrounding Luckin stock are ugly. The fundamentals are not. Fundamentals always trump optics. Long-term, Luckin will emerge as proof of that.
On the date of publication, Luke Lango did not have (either directly or indirectly) any positions in the securities mentioned in this article.
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