Some investors may have written off the stock of Luckin Coffee (LKNC.Y -0.32%), and for a good reason. In early 2020, the hypergrowth coffee company, labeled as China's answer to Starbucks (SBUX -0.35%), was caught falsifying sales and profit data ahead of a big capital raise.
The result was a de-listing from Nasdaq and a messy ousting of former management that was difficult and time consuming to achieve.
However, some may be surprised that even as stocks have swooned this year, Luckin's American Depositary Shares, which still trade over the counter, are up a scorching 82.3% in 2022. Here's how the company did it and what other catalysts could be in the offing.
Closing the bankruptcy issue, refreshing the board, and getting back to normal
Earlier this year, the liquidation of Luckin's convertible notes was completed, and the company exited its Chapter 15 bankruptcy. For reference, Chapter 15 isn't like Chapter 11, in which a company is liquidated or restructured. Rather, the Chapter 15 has to do with claims on convertible notes issued to U.S. investors in order to prevent further lawsuits against the company from those U.S. investors.
Luckin was able to satisfy those investors by paying some cash, stock, and 9% bonds to the note holders in an arrangement worked out between bankruptcy courts in the Cayman Islands and Southern District of New York. Just last month, the company actually paid off those 9% offshore bonds, ridding itself of that high-interest debt and making the company debt free.
As a result of the restructuring, Grand Court of the Cayman Islands closed the case and dismissed the Joint Provisional Liquidators (JPLs) from their duties.
Summing it up, pretty much all the remaining baggage and overhanging legal questions were put behind the company in March, so investors can look at the current numbers without worrying about more legal surprises going forward.
Recent results have been surprisingly good
Under new CEO Jinyi Guo, Luckin has actually rebounded fairly well over the past two years. By steadily growing its store count in a controlled manner, growing franchisees in lower-tier cities, innovating new beverage products and raising prices, Luckin showed impressive growth and increased profitability.
In the second quarter, Luckin grew revenue 72.4%, with same-store-sales growth of 41.2% and transacting customers up 69.6%. Store-level operating margins increased from 23.1% to 30.6%, helping overall adjusted non-GAAP (generally accepted accounting principles) operating margins increase from 1.2% to 10.4%.
These results are even more impressive considering Luckin was operating in an environment of widespread lockdowns. In April and May, the company had 900 stores temporarily closed due to Shanghai's lockdowns; however, that eased to just 150 stores in June and 100 stores in July. For reference, the company had nearly 7,200 stores as of the end of June.
Given that Luckin had fabricated sales figures prior to March 2020, some may be skeptical of these recent growth figures. However, back when sales were fabricated, Luckin was reporting revenue growth in the 500% range. So even though these are robust numbers, they're much more plausible than before.
China has a very low penetration of coffee drinkers compared to other advanced economies, but the rising middle class appears to be taking to their newfound coffee addiction just as we all have. In that light, rapid growth of coffee consumption shouldn't come as too much of a surprise.
Is it a buy?
If one annualizes last quarter's adjusted operating income of $51 million to just over $200 million, Luckin doesn't look too expensive, at about 23 times operating earnings, despite having about $500 million in cash, or about 11% of its market cap. That valuation is in line with many large, more mature restaurant stocks but is actually quite cheap if Luckin can continue posting these types of growth rates, along with operating leverage on top of its corporate expenses.
The ADS (American depository share) may currently be held back by the fact that they still trade over the counter. Reports circulated in January that management would try to re-list on the Nasdaq, but management didn't provide details on the recent conference call, saying only that it "remains committed" to U.S. capital markets and emphasized a new ESG Sustainability Committee and refreshed board of directors.
Of course, risks remain. Aside from the issues surrounding its re-listing and questions around U.S.-listed Chinese stocks, Luckin may have to contend with new competition. It was recently reported that former Luckin Chairman Charles Lu, who spearheaded the 2020 fraud and then tried to sabotage current management after he was forced out, is planning a new coffee venture called Cotti Coffee. So while Luckin's eye-opening financial performance is a positive, it is also likely to attract competitors.
Still, that's a much better option than being heavily indebted and struggling operationally. That's why, for investors comfortable investing in Chinese companies, those who may have abandoned Luckin after the 2020 sales scandal may want to give the stock another look today.
