Starbucks vs. Luckin: What to Consider

In today's episode of MarketFoolery, Motley Fool senior analyst Jason Moser is back for some more market news talk. The second quarter was a hot mess for Macy's (M -2.03%), and the company's long-term performance isn't much better, but there's reason to believe this one could be more value play than trap. Luckin Coffee (LKNC.Y -3.71%) shared its first report as a public company, and Jason makes a case for just focusing on Starbucks (SBUX -1.02%) instead. Space-as-a-service company We Company (aka WeWork) released its S-1. Tune in to learn why investors should probably stay far away, at least for a little while. Also, where you can learn more about the upcoming IPO.

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. A full transcript follows the video.

This video was recorded on Aug. 14, 2019.

Chris Hill: It's Wednesday, August 14th. Welcome to MarketFoolery! I'm Chris Hill. And as I say from time to time, I'm the only one who's paid to be in this studio. The analysts are not paid to be in this studio. So when an analyst says, "Sure, I can come on MarketFoolery," and then, I don't know, 90 minutes before the show, the analyst says, "Ah, something's come up," I have no recourse because they're not paid to be here. So, joining me in studio today, Jason Moser!

Jason Moser: Well, you have a little bit of recourse, and that is in the form of the diatribe that we were all just made privy to.

Hill: No, no. Just... just reminding folks. If people are like, "Why is Jason on two days in a row?" That's why! Because Jason is the ultimate relief man!

Moser: Well, I like that! I mean, I'll take that role. I've been, thankfully, involved with MarketFoolery from the start. I feel like I have elevated myself to the level where I am paid to be in here, because I just enjoy doing it and talking with you. You could turn the microphones off, and we could sit here and talk stocks for an hour, I'd still be fine with it. But, hey, it is what it is, and I'm thrilled to be here for another day!

Hill: We can't be in here for an hour, and I will share why later in the show. But we're going to get our first look at an upcoming IPO. We've got a newly public company in China that's issued their first public quarterly report. 

We're going to start with retail, though. Macy's second quarter was... is "disaster" too strong a word? Because Macy's profits were much lower than expected. They cut guidance. The stock is down 15% this morning.

Moser: I don't think disaster is too strong. I think management has the opportunity to get out in front of this stuff before it really does happen. I think they just set inappropriate expectations. It does feel like with Macy's, you're never surprised when you see this, right? When you see the miss and/or the guide down, and the stock reacting this way. And, I mean, I'm not the ultimate Macy's skeptic, I just feel like I'm not surprised when this happens. When they guide up and the stock pops on news, that's surprising. And that's probably just where we are with the 21st century retail environment. But, when you look back over one, three, five years, this has just not been a good stock to own. And there are a lot of good reasons why. The top line is down a total of 11% since 2015. They're not growing. Net income is down 33% since then. Earnings per share down 22% since then. They've burned through a considerable amount of cash along the way. And actually, if you look at their balance sheet, their cash and equivalents is down 70% from 2015. Now, thankfully, that's not being blown on a lot of share repurchases. But they're yielding 7.8% now. [laughs] That's not really where they want to be. That's in that territory of potentially unsustainable if business stays the way it's going.

There are a lot of challenges they're facing. They made reference to China in the release. But it's not like they pointed out China as the reason for the guide down, either. In fact, they made the point that the revised guidance does not reflect potential problems from the trade dispute with China. There are a lot of reasons right now to be down on the stock, for sure. 

Hill: Even further back than five years with Macy's, you look basically from 2008 to 2015, and the stock is just a steady march higher. And one of the things we talked about on the show at the time was just what a great job Macy's was doing back then in terms of revenue per square foot. They managed their store footprint so well. You never heard anyone talk about Macy's, "They have too many stores. They need to close underperforming stores." They did such a good job there. And now that we have the benefit of what happened after 2015, I'm wondering if, in some ways, that lulled management into this false sense of security. "We don't need to invest in macys.com. We don't need to really build up our e-commerce channel. Look at what a good job we're doing with the physical stores." Because, they were doing a good job with the physical stores. In some ways, it's the opposite of what we saw with Target and Walmart, where they did decide to heavily invest in e-commerce, and those numbers are trending higher.

Moser: There probably is a good chance that that they felt like they really solved the biggest problem in physical stores and foot traffic, and managing that well. Just sort of took their eyes off the ball, particularly from an inventory perspective. We're seeing time and time again, they are having challenges regarding inventory because either they're missing something on a fashion side, or they're not coming up with lines that are as compelling for consumers when they make changes in the seasons. Retail is hard. We talk about that all the time. It's really difficult. And I do want to give them credit where credit's due -- their digital business posted its 40th consecutive quarter of double-digit growth. That's 10 years, when you think about it. Their footprint, digitally speaking, is bigger. Mobile remains the fastest-growing channel. And that's fine. But to your point, really, that doesn't surprise me. It should be. We knew what these challenges were a long time ago, and we would have dinged them even harder if these results weren't that good. And so, while they're good, listen, it's not enough. And, again, when you go back to retail, it is really about managing your inventory and making sure you're putting stuff out there that people want to buy. 

It all makes me think back to, when you look at the one, three, and five-year charts of this stock, and while it's not been a good one to own, there have been points where buying it along the way might have made sense. When it comes to these retailers, you start thinking, alright, is this an opportunity? Is this something I should be looking at? Is it a value play, or is it a value trap? With Macy's, I don't think we're at a point where they're the next JCPenney. I think they possess the brand power and the know-how and the ability to weather this kind of storm. I do think, maybe there is the possibility here, with the catalyst of a positive holiday season and getting that inventory back in shape there, maybe there is a value opportunity here.

Hill: You read my mind. This stock is close to a nine-year low, and the next two quarterly reports from Macy's are going to include the two most important seasons for a major retailer, and that is back-to-school and Christmas.

Moser: I don't want to toot our own horn, but that's what makes us so good, Chris -- reading minds. We've been doing this together for so long.

Hill: [laughs] Let's move on to Luckin Coffee, which released its first quarterly report as a public company. Luckin is the coffee start-up in China that went public back in May. They lost more money than expected. The stock is down 15%. I feel like this report from Luckin Coffee is essentially a Rorschach test for investors. There's stuff in here for bears, and there's stuff in here for bulls.

Moser: There is. My first inclination in seeing that they reported was not to go to their release, but rather to go to Starbucks' release and earnings call from earlier. That is really the benchmark. I like to say that investing is as easy or as difficult as you want to make it. For me, Starbucks is investing easy. Luckin is probably going to be investing really, really difficult. And that's not really a ding necessarily on Luckin. It just is that Starbucks is in a really good position when it comes to coffee in China. I'm going to give you an over/under here, I want you to give me your bet. Starbucks' mention of the word China on their most recent earnings call. I'm going to give you an over/under number of 50. Are you going over or under?

Hill: 50?

Moser: Yeah.

Hill: I'm going to go under.

Moser: It was 63. When you look at Luckin, that is a China play. That's China, coffee. That's what it is. That's why I went to that Starbucks call to look at that. You're looking at language management's using with Starbucks that China performed extremely well for the quarter. Store count was up 16% to almost 4,000, which is more stores than Luckin has. Starbucks has 9.1 million active rewards members in China alone, up 36% from the year ago, and they have a relationship with Alibaba that's now bringing a digital relationship to consumers in China. And the reason why I kicked this all off about Starbucks is because ultimately, these are the hurdles that Luckin is going to have to clear if it's going to be a compelling investment for people looking, maybe, for pure China exposure, or for someone to really take on Starbucks in China.

I'm not saying it can't do it. Let's give them some credit here where credit's due. Average monthly transacting customers in the quarter for Luckin were 6.2 million. That was up 410% from the second quarter of 2018. So, they are doing the right things in generating traffic and selling stuff. But, they have a really strong competitor there in Starbucks. And to me, I don't see any reason why you would want to invest in Luckin when you could just invest in Starbucks.

Hill: I think part of the bull case is, you look at how quickly this company has grown, you look at the fact that Luckin has nearly 3,000 stores in China, and they basically started two years ago.

Moser: Happened really fast. 

Hill: Starbucks has been there for longer and has somewhere in the neighborhood of 4,000 stores. I think part of the bull case is, certainly, the stock is on sale 15% today, but also, that growth story. If you're comfortable waiting a little bit, then I think Luckin Coffee looks more attractive to you. I do think, however, that one thing that's going to be interesting to watch with Luckin is not just, what do their numbers look like in the next quarterly report and the one after that; but also, does it look like they are learning from their mistakes? You can look at this most recent quarter and say, "OK, the downside to heavy discounting is, it's going to hurt your margins. The upside is, we're just trying to get people in the stores," and this is a legally addictive product, and if they can get people -- this is one of those strategies that, a year and a half from now, they may be putting up some really strong comp numbers. That's the thing I will be watching with Luckin. Are they making the same mistakes in the next couple of quarterly reports? And, what does management say about them?

Moser: I think that's a really good point. Mainly, I think it's because Luckin is doing so much so quickly. They're growing so fast. They're making big investments. Things are happening very quickly. That's resulting in these really impressive growth numbers. And you're right, you're going to invest in this company because you think that growth is there. What'll be difficult, really, is, to your point, looking for those mistakes. They may not even have the opportunity to try to assess those mistakes until well after they've made all of these massive investments in this fast growth. That's one of the prices you pay. It looks great in the short run, but was it something that will reflect in longer-term sustainability? That question is yet to be answered.

Hill: Luckin is doing a lot of growing, which means they're doing a lot of hiring. You know who else is doing a lot of hiring? WeWork. 

Moser: Just a little bit.

Hill: WeWork is going public. The S-1 filing is now available for all to see. WeWork is looking to go public as early as next month. For those unfamiliar, WeWork -- I believe they have actually formally changed the name of their company from WeWork to We Company. This is the shared working space business. I would say, from a brand standpoint, they're probably the leader in that regard. 

Moser: I think so.

Hill: They're getting a lot of attention today because, holy cow, are they racking up losses.

Moser: [laughs] Yeah. We're not going to do a deep dive into every reason why you should or should not invest in this company. This is a cursory glance at where things stand. There is a lot of good and there is some bad. I try to stay open-minded when I see any of these companies. But really, a lot of investing is about spotting BS from a mile away, and I feel like they just stuck it right out there in the first couple of sentences of the S-1, when they say, quote, "We are a community company committed to maximum global impact. Our mission is to elevate the world's consciousness." I don't know, man!

Maybe they're just taking themselves a little bit too seriously, or maybe I'm not thinking big picture enough about it. They basically pioneered this space-as-a-service membership model, so why don't you make your mission central to that? They are losing a lot of money. I mean, when you look at the numbers, it is pretty astounding. In 2018, they brought in $1.8 billion in revenue. They spent $3.5 billion to make that. So, there's an operating loss there of $1.7 billion in total. Real estate is an expensive business. We know that. That's nothing new. When you look at how they make money, they monetize their platform through selling memberships, providing value-added products through those memberships and services. They're essentially trying to leverage that platform beyond just work. It goes back to what we talked about with Lyft and Uber. It's really about figuring out what you're going to do with that network. I think that We has done a good job in building a good brand and a potentially very valuable network that they could do a lot of things with. But we've already seen a number of examples earlier this year -- there is no reason in the world why you should feel compelled as an investor to jump in on this IPO. I just don't see any reason in the world why you wouldn't just say, "You know what? I'm going to watch this play out and see what these guys do." There are enough questions out there.

Hill: But what about the fact that their mission is to elevate the world's consciousness?

Moser: I mean, that's a very admirable quality, but you know the first thing that made me think of, in all honesty? The first thing that came to my mind?

Hill: Any marijuana company?

Moser: Well, that too. And this probably goes hand in hand with that. It was Elevation Burger, that restaurant. They're basically trying to offer you burgers with better ingredients. They're elevating our consciousness. I don't know. Listen, they have three share classes. This is going to list the Class A shares, but they've got Class B and C. It's 20 votes per share in those B and C shares vs. the one you get for A. So, you know what the deal is going in there. I think there are some questions regarding leadership. Neumann has apparently borrowed a lot of money against some of his holdings in this business. They're essentially trying to take the challenge of a high fixed cost in business that you would pay for real estate and take that fixed cost away from you, so that you pay as you go, you pay for what you need, and you don't have to worry about paying for all the space if you're not using it. That's cool, I like that. But the flip side is they're taking on that challenge. They're going to be paying that high fixed cost. And that's the business. They're going to be leasing a lot of real estate, and they're finding real estate to lease. And when you go to those really big commercial markets, that real estate is very expensive. 

It's going to be a matter of how they can grow those memberships, how they can leverage that platform, and ultimately trying to figure out if the stock price does make any sense. My suspicion is, it will go public, the stock price will not make any sense, and we'll see it pull back to some semblance of reality until they can prove themselves.

Hill: We're not doing a deep dive on We Work's S-1, but our friend and colleague Dylan Lewis will be doing a deep dive on this Friday's Industry Focus. Check that out!

You and I have to head to another studio because we're doing a YouTube Live this afternoon. You, me, Seth Jayson. We're going to be talking about a couple of industries with tremendous growth potential -- AI and augmented reality. For anyone interested, by the time you hear this, we'll have done the YouTube Live. It'll be posted on The Motley Fool's YouTube channel, which is free to subscribe to. Check that out! Looking forward to it!

Moser: It's going to be a lot of fun!

Hill: Thanks for being here, man! I appreciate it!

Moser: Yeah, thanks for having me!

Hill: As always, people on the program may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. That's going to do it for this edition of MarketFoolery! This show is mixed by Dan Boyd. I'm Chris Hill. Thanks for listening! We'll see you tomorrow!