Two years ago, Luckin Coffee (LKNC.Y -3.71%) was one of the hottest growth stocks on the market. Shares peaked at an all-time high of $50 in January 2020 just months after its IPO at $17 in May 2019. But an accounting scandal and C-suite drama have sent the stock roughly back to where it started. Let's explore why Luckin Coffee might be on track to regain its old valuation over the long term.
What went wrong for Luckin?
Following an internal investigation in 2020, Luckin Coffee admitted that its former management fabricated $310 million worth of 2019 sales. The news led to a series of fines and the stock's delisting from the Nasdaq stock exchange. By its lowest point in June 2020, shares had fallen by a stunning 97% to just $1.38 as investors ran for the exits. To rectify the situation, Luckin Coffee brought on new management and filed for Chapter 15 bankruptcy protection to restructure its debt without impacting business operations.
In April 2022, the company successfully emerged from all bankruptcy proceedings. And with a share price of $16.5, its market cap of $4.3 billion is now roughly the same as when it first hit the market back in 2019 at $4.2 billion. The difference is that Luckin Coffee is a far better business now and arguably better than when it peaked at $50 per share.
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Luckin may be in an even stronger position now
Luckin's most recent data, from the second quarter of 2022, shows the company's net sales growing 72% to 3.3 billion yuan (also known as the renminbi) or $493 million. While this growth rate looks like a significant deceleration from the pre-scandal growth rate of 698% reported in the corresponding period in 2019, it reflects the company's increased maturity and evolved business strategy. Instead of chasing unprofitable growth at all costs, management is now using a more strategic expansion strategy -- closing unprofitable stores and opening in locations with the most bottom-line potential.
The company has also implemented partnership stores, a franchising strategy that can help it expand while shifting some of the operational risks and overhead to the franchisees. Luckin's franchise revenue increased 178% to $116.3 million compared to zero before the crisis.
The changes are making a big impact on Luckin's bottom line. The company now reports a generally accepted accounting principles (GAAP) operating income of $36.1 million compared to an operating loss of $100.5 million in Q2 2019. And profits can be expected to grow as management continues implementing the new strategy. Essentially, Luckin has transitioned from a cash-burning growth company into a more methodical and profit-driven business that looks more likely to stand the test of time and generate sustainable value for investors.
Looking forward
To be fair, finding Luckin's rightful valuation will be more complicated than simply comparing its current data to its past data because many things have changed in that period. After the accounting scandal, investors will likely be skeptical of Luckin, even as it improves. Furthermore, as an over-the-counter stock, the shares are less liquid than before the crisis.
That said, with new management, new auditors, and increased scrutiny from regulators, Luckin's filings are likely as accurate as they will ever be. And according to the Financial Times, the company plans to eventually relist on the Nasdaq, which will boost its trustworthiness and availability to American investors. With a new business strategy and dramatically improved bottom-line performance, it could only be a matter of time before Luckin Coffee reaches (or exceeds) its previous highs.
