Luckin Coffee: Growing Profitability With New Product Offerings

seekingalpha09-27

Luckin Coffee is a hold due to its robust balance sheet, profitability, and growth fueled by new attractive products.LKNCY's quarterly revenue grew 33.33% QoQ and 35.5% YoY, driven by strong product ...

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Robert WayThe Chinese coffee market touched RMB265.4 billion ($32.29 billion) in 2023 and was estimated to reach RMB313 billion ($44.5 billion) by 2024. This industry was spearheaded by global US firm Starbucks Corporation (SBUX) which crossed to Beijing in 1999, before being joined by market leader Lucking Coffee (OTCPK:LKNCY) later in 2017. Coffee delivery orders have also surged by 66% over the past 4 years, with coffee shops selling more than 930 million cups through deliveries. As of 2024, about 7 companies controlled the Chinese coffee brand market, led by Luckin Coffee which opened its 20,000th store in July 2024.   Statista (as of Q1 2024)In this article, I will explain why Luckin Coffee is a hold due to its robust balance sheet including profitability and growth fueled by new attractive products. Quarterly earnings review Luckin Coffee’s quarterly revenue grew 33.33% (QoQ) from RMB6.3 billion in Q1 2024 to RMB8.4 billion in Q2 2024 and a further 35.5% (YoY). There was a 39% (YoY) growth in product sales (having launched 22 new products in Q1 2024). Even more interesting is that the sale of freshly brewed drinks (served in-house and as deliveries) accounted for 71.6% of Luckin's total net revenue, which stood at RMB6 billion. As seen above, store performance has been growing for Luckin, reaching 20,000 stores as of July 2024. Like product sales, self-operated sales generated a 39.6% (YoY) growth in revenue at RMB6.3 billion ($863.7 million) against RMB4.5 billion realized in Q2 2023. Noted earlier (according to Statista) was that the number of on-premise stores for Luckin Coffee in China had surpassed those of Starbucks. The latter has a total of 39,477 stores globally (up 6%, YoY). I will compare the enterprise value at the store level of these two beverage chains to determine which company generates more operating revenue (and by how much). Luckin Coffee’s enterprise value (EV) as of Q2 2024 stood at $6.15 billion, while that of Starbucks was $130.14 billion. With 20,000 stores, it means Luckin’s EV per store is $307,500 against a net revenue per store at RMB420,000 ($59,731). As of June 30, 2024, the total net revenue for Starbucks was $9.114 billion. The enterprise value for every Starbucks store stands at $3.3 million against a net revenue (per store) of $230,866. These calculations show that while every Starbucks store is valued at least 10 times more than each Luckin Coffee, it only generates 4 times more net revenues (from a global perspective). If we consider only China, then Luckin Coffee has a higher net revenue generation per store. On its part, Starbucks’ International market (that includes China) operating income declined 23% (YoY) in Q3 2024, to $288 million while its total net revenue was down 1% (YoY). The company attributed this decrease to lower sales of products and equipment in the region. For the three quarters of FY 2024, the company witnessed an 18% (YoY) decrease in operating income to $763 million from $930 million realized in the same period in FY 2023. I believe Starbucks needs a partner in the International space (especially in Asia) and a merger between these two companies may grow SBUX’s revenues. Just to add, the rise of Starbucks with an EV of almost $200 billion shows the spread of the Western culture of coffee houses globally. Even interesting is that Luckin Coffee is growing in China, which has historically been known to favor tea. By December 2023, reports indicated that China had “overtaken the US as the largest branded coffee shop market” with China serving as the second-largest market for Starbucks. In the Fiscal Year 2023 Chinese coffee outlets had grown 58% (YoY) “to reach 49,691 stores” with Luckin Coffee owning almost half of these stores. Image and Financial Recovery Despite these impressive numbers, LKNCY has been on a recovery path, having faced immense short-selling after its IPO in 2019 and later admitting to financial impropriety in 2020. While LKNCY is down 36.81% (YoY), it has outperformed both the S&P500 and SBUX over the last 3 years.   Seeking AlphaIt has gained 38.39% in the last 3 years while the S&P500 has grown 28.67% against a decline of 17.23% from SBUX. Q2 2024 saw Luckin hit a record new high for its “average monthly transacting customers” (AMTCs) at 69.7 million, representing a 61.8% (YoY) growth. New transacting customers in Q2 2024 were almost 25 million. With the increase in the AMTCs, it opened 1,371 net new stores in the quarter, with more than 13,000 self-operated stores while the remaining~ 7,000 stores were operated as partnerships. In 2023, more than 100 stock-keeping units (SKUs) were launched by Luckin Coffee, and in Q2 2024, it added “30 new SKUs including the aromatic coconut flavored latte, Lemonade Americano and light coffee series with super cup options.” Further, more than 5 million cups of the “light coffee lemonade were sold in the first week of launch.” Another aspect to consider is that Luckin Coffee is strengthening its source of coffee beans. Apart from China, Luckin also gets its raw materials from Ethiopia, Brazil, and Yunnan. In its Q2 2024 earnings call, it stated that it had agreed to “purchase 120,000 metric tons of coffee beans from Brazil (the world’s largest coffee producer) over the next two years.” Risks Luckin Coffee has a debt of $776.07 million against a cash balance of $493.69 million. The rapid growth of stores may also require more capital indicating a rise of debt into 2025. Additionally, China’s economy shows continual signs of deflation caused by a general decline in aggregate demand, and lower net exports and investments. This presents a complex challenge since coffee prices have reached their 10-year-high. It may tighten LKNCY’s margins.   Trading EconomicsValuation LKNCY has a forward price-to-earnings ratio of 19.24X against the industry average of 18.01X. It leaves off a difference of 6.84% showing the stock is slightly overvalued, and we may see some downside. However, this valuation is stronger than that of SBUX which has a forward P/E ratio of 26.81X. Bottom Line Luckin Coffee is a hold due to its robust balance sheet fueled by an array of profitable new product offerings. The company has dominated the Chinese coffee (and by extension the beverage market) beating global leaders, Starbucks in coverage and expansion. However, the company faces the challenge of the growing deflation of the Chinese economy and rising coffee prices that may tighten margins into 2025.  Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. 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