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Why Luckin Coffee Soared 21.8% in February

By Royston Yang - Mar 4, 2020 at 2:22AM

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But the company still needs to prove it has a viable business model.

What happened

Shares of Luckin Coffee (LKNC.Y 2.72%) soared 21.8% in February, according to data from S&P Global Market Intelligence.

The coffee chain famous for its pick-up stores in China has been rapidly expanding, with total store count more than tripling in just a year, from 1,189 stores to 3,680 as of Sept. 30, 2019. Revenue has jumped almost sevenfold year-over-year for the third quarter of the fiscal year 2019, soaring from 240.8 million yuan ($34.6 million) to 1.54 billion yuan ($221 million) .

However, the two-year-old start-up continues to burn significant amounts of cash and incur huge losses, which seem to be a symptom of its breakneck pace of growth.

A smiling woman looks at her smartphone while holding a to-go coffee cup.

Image source: Getty Images.

So what

On Jan. 31, seeing an opportunity to criticize the company's rapid growth, Muddy Waters, a short-seller, published an 89-page report alleging fraud and describing a "fundamentally broken business." The stock proceeded to crash to a low of $31.35 on Feb. 3, only to rebound strongly after the company released a rebuttal to deny what it called "false and misleading allegations."

By the end of February, the stock had largely recovered from the losses it sustained a month ago and was trading back at the $39 level.

Though COVID-19 had affected the company and forced it to temporarily close some stores, the impact is not perceived to be significant, as the company has a wide footprint of stores all over China. To date, though, the company has yet to quantify the potential impact of the store closures, and this is something investors should continue to monitor.

Now what

With the impact from the short-seller report largely neutralized by the company's quick response, it appears that the current share price may also have figured in the effects of COVID-19, even as the situation in China continues to improve, with fewer deaths and a declining rate for new cases.

Charles Lu, co-founder and chairman of Luckin, believes that China's coffee market remains underpenetrated and that there's vast potential for the company to continue growing. However, the company needs to prove to the market that it has a viable business model and that it can eventually turn profitable instead of just burning large amounts of cash.

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