The name Luckin Coffee (LKNC.Y -3.71%) probably makes you think of the dangers of investing in Chinese stocks. But now, the company's narrative is changing. Three years on from the company's crisis, in which it was discovered that its previous management had fabricated $300 million worth of sales, this controversial coffee shop has begun to reinvent itself.
1. Luckin Coffee is turning over a new leaf
While it could take years (if ever) for Luckin Coffee to fully shed the stigma of its previous fraud, management has done a great job of turning the ship around. In April, the company emerged from Chapter 15 bankruptcy -- a process designed to restructure its debt in the U.S. without materially impacting the company's day-to-day operations.
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As part of the reorganization, Luckin Coffee and some of its U.S. creditors agreed to retire a portion of its $460 million in debt in return for $320 million in cash along with new bonds and shares -- with the goal of improving Luckin's capital structure and turning over a new leaf. The company also agreed to a $180 million fine to the Securities and Exchange Commission (SEC) to settle accounting fraud charges for overstating its 2019 revenue.
Luckin Coffee's new CEO, Jinyi Guo, recognizes that some may still be skeptical of the company because of its history. And CNN reports that Luckin has brought in external lawyers to review its operations.
As a Chinese company, Luckin isn't necessarily held to the same reporting requirements as its U.S. counterparts, but the high level of external scrutiny from lawyers, the media, and regulators should be enough to keep management honest.
2. Business is booming
Luckin Coffee's first-quarter earnings were a slam-dunk success. Total net revenue soared 90% year over year to $379.3 million as the company enjoyed a healthy same-store sales growth rate of 42% and opened 556 new stores, bringing its total store count to 6,580. Rival Starbucks operates just 5,654 locations in China, making Luckin Coffee the largest coffee chain in mainland China by store count.
Luckin Coffee's unique business model may be behind its rapid growth. Unlike Starbucks, which owns and operates all its Chinese locations, Luckin Coffee employs a franchise business model where partner stores license its name and products in return for a profit-sharing agreement. As of the first quarter, 1,905, or 29%, of Luckin's stores are partnership stores.
Luckin Coffee's bottom-line results are also impressive. The company reported its first net income of $3.1 million, reversing a roughly $35 million net loss in the prior-year period. The swing to profitability highlights the potential of Luckin's business model as it scales operations.
3. A valuation too good to ignore
Despite its spectacular growth rate, with a price-to-sales (P/S) ratio of just 1.9, Luckin Coffee is valued significantly lower than its closest rival, Starbucks, which trades for 2.7 times sales. The Chinese company's controversial past will be a long-term overhang on its stock price, but its booming business and dirt cheap valuation make it a great pick for investors willing to tolerate some uncertainty for the potential of market-beating, long-term growth.
