Luckin Coffee has been a thorn in Starbucks’ side, but with the coronavirus pandemic raging through the U.S. could Luckin get the upper hand in China?
Update: 04/02/2020
On April 2, two days after this article was published, Luckin Coffee stock fell as much as 81% in pre-market trading due to fraud allegations (and not because I wrote this article). The best thing investors in LK can do now is wait and see what happens with this investigation.
Barely three months into 2020 and we’ve experienced a potential World War III, raging wildfires, and now a pandemic. In February, China was at the epicenter of a disease that is now raging across the U.S. and Europe, with America now having the single-largest cluster of confirmed cases.
It was only in January that we were wondering when the likes of Virgin Galactic (NYSE: SPCE) and Tesla (NASDAQ: TSLA) would stop growing, but now the market is in a state of volatility. However, China is coming back to life, and one of the main beneficiaries of that is Luckin Coffee (NASDAQ: LK). Its 4,500 stores in China already surpass the 4,300 Starbucks (NASDAQ: SBUX) in the important Asian market, despite only launching three years ago.
With Starbucks now closing stores all across the world, is Luckin in a unique position to take advantage of this storm?
What is going on with Luckin’s stock?
Much like Starbucks encroached on Dunkin’s (NASDAQ: DNKN) all those years ago, Luckin could become the next big challenger in the coffee space. Its growth has been extraordinary during its so-far young lifespan. In China, the world’s second-largest economy, it appears to have adapted to the fast-paced lifestyle of the massive country.
Its stock has, of course, taken a hit during the coronavirus pandemic. Having hit highs in mid-January, up more than 290% from its May 2019 IPO, the stock has fallen hard, but is still up more than 30% from its IPO. This compares to Starbucks, which has fallen more than 8% in the past year, and the S&P 500’s (NYSEARCA: VOO) 7% drop.
By the time of its IPO, Luckin was opening 8 stores per day, increasing over time, but slowing down due to the recent virus. This growth is far outpacing Starbucks, which has far more exposure to loss during this pandemic, with 31,000 stores across five continents. As the virus spreads in the U.S. — its most important market — its losses will mount, reducing expansion opportunities once this all blows over, which can hurt them as Luckin gets back on track in its home market.
Before the virus hit, Luckin was also showing promising signs of being a long-term winner. China’s coffee market is booming, leaving massive room for growth. Its coffee consumption is roughly 5 cups per year, per capita, compared to 400 cups in the U.S. and according to analysts, this is increasing by 20% annually. The only way from here is up, as shown in its 557% revenue increase year on year in its November earnings call.
Finally, the company is largely automated, and its stores are completely paperless — all orders are placed and paid via the Luckin app and then delivered to customers at requested locations or collected in-store. The move was enough to scare Starbucks, which last year announced its partnership with Alibaba (NYSE: BABA) and added delivery options for more than 2,000 of its China-based stores.
In a post-virus world, automation and speed may be the driving force behind many businesses, giving Luckin a healthy lead.
The problem with Luckin…
There is no point glossing over the elephant in the room though: Luckin is a very young company.
Despite its awe-inspiring revenue growth, much of this is down to the opening of new stores in recent years, which has also increased its costs exponentially. Luckin reported a $324 million net loss in 9 months at its November 2019 earnings call, largely due to marketing and technology growth spending, just to get customers in the door.
Not only that, but all this growth and spend has left the company with no clear path to profitability (not that this has phased investors before). It has also already begun to produce more capital intensive stores (just like Starbucks), and producing lower-margin products such as cakes and fancier beverages.
Can Luckin become the next Starbucks?
It is simply too early to say, and the truth is that at the moment there is so much growth opportunity in China, that there’s more than enough room for Starbucks, Luckin, and any other players.
Luckin’s strength lies in its differentiation from Starbucks, as a fast-paced, easy to use coffee provider. By expanding into new arenas such as lavish stores and food, it cannot possibly hope to compete with the biggest brand in coffee. What’s next, a deal with Beyond Meat (NASDAQ: BYND)?
It might be more prudent for it to go back to its roots.
MyWallSt operates a full disclosure policy. MyWallSt staff currently hold long positions in Luckin Coffee and Starbucks. Read our full disclosure policy here.