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Facing Headwinds, Luckin Stock Could Drop Lower


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Facing Headwinds, Luckin Stock Could Drop...

What’s the next move for Luckin Coffee (NASDAQ:LK) stock? Shares in China’s answer to Starbucks (NASDAQ:SBUX) soared after its 2019 IPO.

LK stock

Source: Keitma / Shutterstock.com

But, with the coronavirus top of mind, along with an anonymous “short report,” shares have dipped from their 52-week high of $51.38 to under $40/share. With this drop, the stock could be a “buy the dip” situation. Especially considering the worst may already be over for China.

On the other hand, there’s plenty of reason why LK stock could head lower. For one thing, the company’s overnight success may not translate into profitability. Also, the stock’s rich valuation leaves it to be “priced for perfection”. Yet, if the company succeeds, and becomes the “Starbucks of China”, all bets are off how high shares could climb.

Despite big potential, chances are LK stock could head lower. Let’s dive in, and find out why.

Is There A Short Case for LK Stock?

Will the recent coronavirus-driven Chinese economic shutdown impact results for LK stock? As InvestorPlace’s Todd Shriber discussed February 28, rival Starbucks may be re-opening most of its stores. But that doesn’t mean there’s strong demand for outside-oriented businesses. Even if the worst is already over, it could take time before foot traffic gets back to prior levels.

On the other hand, as InvestorPlace’s Matt McCall recently discussed, coronavirus could counterintuitively benefit LK stock. Starbucks’ China footprint is largely sit-down locations. But, Luckin primarily operates grab-and-go kiosks. They are also rolling out unmanned vending locations to drive future growth. In other words, Chinese consumers may regard Luckin’s locations as “safer”, driving business away from Starbucks and towards Luckin.

However, coronavirus isn’t the only negative at play with LK stock. There are many red flags that could indicate trouble for Luckin down the road.

Late last month, prominent short-seller Muddy Waters Research tweeted an anonymous report detailing allegations of the company inflating sales and shifting expenses to create the perception of store-level profitability. The report also discusses other red flags, such as the checkered past of Luckin CMO Yang Fei.

Yet, another prominent short-seller disagrees. Citron Research also received the anonymous report. But, as they discussed in their Tweet, Citron’s due diligence failed to back up the report’s allegations. According to Citron, “calls with competitors” confirmed Luckin’s numbers, as well as the fact the company’s business is “on fire in China”. Citron is long LK stock.

This clash of the short-seller titans makes it tough to make a call. But it could be possible that Luckin is “on fire”, yet its agressive business model is unsustainable.

Sales Growth is Good, But Are Profits Attainable?

Heavy discounts and aggressive store openings are the secret behind Luckin’s overnight success. All of this aggressive growth has come at the cost of profitability. Long-term, Luckin needs to convert enough of its traffic into full paying customers.

Is this possible? Analyst consensus calls for Luckin to be profitable by 2021, with $1.34/share in estimated earnings. In other words, LK stock may now be trading for 29.6 times 2021 earnings. Yet, this consensus is making a lot of assumptions. Consensus calls for revenues of $3.52 billion, more than 4 times Luckin’s estimated 2019 sales of $741.6 million.

It’s possible Luckin could grow its sales nearly 5-fold in less than 2-years. But, is this attainable without continued discounting? Not an apples-to-apples comparison, but look at ride-share app companies in America like Uber (NYSE:UBER) and Lyft (NASDAQ:LYFT). Both companies saw parabolic growth as they sold services at a loss to drive sales. Yet, both companies remain unprofitable.

But this may not matter to LK stock bulls. Investors long Luckin are looking for the company to scale into a Starbucks-sized competitor. With a market capitalization to match. Luckin currently has a market cap of $10 billion, versus $92 billion for Starbucks.

At first glance, this implies massive upside for LK stock. Yet, Starbucks wasn’t build in a day. It took decades for the coffee chain to become a highly-profitable global powerhouse. With high expectations priced into Luckin shares, the stock could take a dive if results fail to live up to expectations.

Bottom Line: LK Stock Could Head Lower

In short, LK stock stands a better chance of falling than rising. Even as China recovers from the coronavirus, the company could see a short-term hit to sales growth. Add in an agressive (and costly) expansion strategy that may take years to be profitable, and it’s tough to justify paying a high valuation (13.5 times estimated 2019 sales) to get in at today’s prices.

Word of warning: LK stock has high short interest. 15.3% of Luckin’s shares have been sold short. If Luckin beats estimates in its next quarterly earnings release, shares could soar to past highs (or more) on a squeeze.

Yet, despite short-squeeze risks, LK stock is a clear sell at today’s prices.

Thomas Niel, contributor to InvestorPlace, has been writing single-stock analysis for web-based publications since 2016. As of this writing, Thomas Niel did not hold a position in any of the aforementioned securities.

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