Chinese coffee chain Luckin Coffee (OTC:LKNCY) is running out of time to restructure its convertible debt, and get its business model right, according to John Zolidis, president of Quo Vadis Capital. As a result, he thinks the stock is overvalued, and rates it a Sell.
"LKNCY has not provided audited financials for any period post-2019," he said. "Also, the stock has recently become impacted by a rule that prevents some brokers from allowing orders (other than closing transactions) or providing quotes. Our view remains that the market cap is too high relative to the profit potential (thus far unproven) of this business."
TipRanks assigns Luckin Coffee a Smart Score of 5 out of 10, citing neutral investor sentiment, bearish blogger opinions, and decreased hedge fund activity. I am neutral on the stock.
The only two positive factors are news sentiment and technicals, suggesting that Luckin's stock is popular among traders, and short-term momentum investors.
Zolidis is among the few analysts following the stock closely, sounding the alarm for its murky financials before its shares crash. (See LKNCY stock charts on TipRanks)
Why the Stock is a Sell
In a research note back in July, Zolidis explained his Sell rating for Luckin's shares.
"Using what information we have, including forecasts from the JPL report, we estimate that Luckin could achieve breakeven by 4Q22. Full-year 2023 could be the first year of positive EBITDA, some EPS, and positive FCF, although not very much. So, what are LKNCY shares worth? At yesterday's close of $11 per share, the EV (noting that cash balance balances are still subject to lawsuits, etc.) was $3.4B implying an EV/ 2023 EBITDA multiple of 24x."
Apparently, investors are in for quick trading gains, ignoring several risks the company faces, like finance and corporate risks, legal and regulatory risks, and production risks.
Then, there are the true believers, who believe that Luckin Coffee is the next Starbucks (NASDAQ:SBUX). There's some merit to this argument. Starbucks has been very successful in China, and Luckin has been trying to catch up with it by opening new stores quickly in its early days. That's how it reached 6,500 stores in 2020, 2,000 more than Starbucks.
Luckin Is not, Cannot be Another Starbucks
Luckin Coffee is not another Starbucks just because it has a business model that rivals Starbucks. It isn't a "third place," where people will share a cup of coffee with friends and business associates, away from the home and office. That's something that was missing from the American urban landscape back in the 1980s and the 1990s, as middle-aged baby boomers were trying to balance work life and family life.
Luckin Coffee is a collection of coffee outlets delivering coffee everywhere, competing on technology and price, rather than on "affordable luxury."
Luckin Coffee also operates in a different social context than Starbucks. China already has its dim sum places where people can socialize with friends and colleagues, having breakfast or light lunch, and sipping tea.
Meanwhile, the company's business model turns coffee into a commodity, meaning a product that everyone can sell. Economists know very well that price wars are detrimental to a business in the long-term. They erode profit margins to the point where the return on invested capital is equal to or below what money can earn elsewhere.
Summary and Conclusions
Hope isn't a strategy. So, goes the old aphorism on Wall Street.
Buying shares of companies hoping they will beat market leaders one day is a long shot in earning superior gains. Unfortunately, that may end up being the case for Luckin Coffee.
The company has yet to provide investors with trustworthy information about its current situation, and its business model hardly matches its main competitor, Starbucks.
Disclosure: At the time of publication, Panos Mourdoukoutas owned shares of Starbucks.
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