LKNCY - Luckin Coffee: Buy This Growth The New Coffee Leader In China

2023-11-28 02:24:16 ET

Summary

• Luckin Coffee's shares have steadily increased since December 2021, with a 103% increase in the last year.
• The company's brand marketing strategy and embrace of digitization are driving its growth and market share in China.
• Luckin Coffee's low-price strategy, online ordering system, and convenient outlets have helped it surpass Starbucks and become China's largest coffee chain.
• Based on the company’s excellent marketing strategy and digitization, I am bullish on the stock and rate it a buy.

Investment Thesis

Luckin Coffee Inc. ( LKNCY ) recovered from a steep share price drop in 2020 due to its fraud scandal, and its shares have been steadily increasing since December 2021. Its shares have increased by about 103% in the last year, and I am bullish on the stock because of its brand marketing strategy , which I believe is the primary driver of this growth. The company has been recording impressive performance in recent quarters, which I believe will keep steering its share prices up if sustained in the long run.

Besides brand marketing, LKNCY has embraced digitization in its operations, which complements the brand marketing strategy and will be a significant growth pillar for this company in the long run. For instance, the company has adopted online ordering, a service that I believe perfectly fits the emerging trends post-COVID and seeks to address consumers’ convenience. For these reasons, I think this company is better positioned to experience strong future growth, so I recommend it to potential investors.

The Brand Marketing Strategy: A Victory Over The Competitors

The development of coffee culture in China has been marked by fierce competition over the years. There is no doubt that several coffee brands have battled for supremacy. Starbucks, the global coffee giant, led the charge as it opened its iconic stores across Chinese cities. However, after emerging, a relatively new player, Luckin Coffee, surpassed Starbucks to become China’s largest coffee chain. I believe this achievement was made possible by its brand marketing methods and strategies, as well as the turnaround strategies implemented following the fraudulent scandal, such as a new management team that devised efficiency-focused measures to achieve profitability, among other measures.

For this article, I will focus on the brand marketing strategy because I believe it has also helped in phasing out competition, besides being effective in steering growth. Based on my analysis, I would categorize the strategy into the following aspects:

Product: LKNCY offers a variety of coffee products, such as espresso, americano, latte, cappuccino, macchiato, and mocha, as well as tea, juice, and bakery products. The company uses high-quality Arabica coffee beans and fresh milk to provide customers with customized options. It also launches new products regularly, such as its fruit tea series , ready-to-drink products, and co-branded products with other popular brands, such as Coconut Tree and Oreo. Its most recent launch is baijiu . The company’s product strategy aims to cater to Chinese consumers’ diverse tastes and preferences, especially the young and urban ones, and to differentiate itself from other coffee brands.

Just to exemplify how LKNCY has used this strategy to differentiate from the competition, I will draw your attention to its coconut cloud latte product, which was a co-branded product with Coconut Tree, a popular beverage brand in China. The product is a combination of coffee and coconut juice, which is unique and innovative in the coffee market. The product has addressed the market gap by providing a refreshing and healthy alternative to traditional coffee drinks and catering to Chinese consumers’ diverse tastes and preferences, especially the young and urban ones. In my view, it is also relevant to the evolving coffee culture in China, as it reflects the fusion of Western and Eastern food cultures and the willingness of consumers to try new things and enjoy different experiences. To show how competitive the product is, it sold more than 660,000 cups on the first day.

Price: The company adopts a low-price strategy, which is one of its main competitive advantages. Its coffee products are priced at about 28 Yuan, which is much lower than the price of Starbucks, which is around 30 Yuan. It also offers discounts and coupons to attract and retain customers, such as giving a free cup of coffee for new users or offering a buy-one-get-one-free deal for regular customers. The company’s price strategy aims to create a mass market for coffee consumption in China and to challenge the premium positioning of Starbucks and other rivals, which I believe has paid off, as shown by the company overtaking Starbucks to become the leading coffee chain brand in China.

Place: Luckin adopted a new retail model combining online and offline channels. The company operates mainly through its app-based ordering system, allowing customers to order and pay for their coffee online and then pick it up from the nearest store or have it delivered to their location within 30 minutes . It also operates cashier-less stores , which are small and convenient outlets that use smart, cloud-connected kitchen equipment to prepare orders automatically. The company’s place strategy has helped leverage the power of technology and data and provide convenience and efficiency for customers, something I believe has contributed to its growing customer base .

These are the major aspects I believe have made a strong marketing method, which has been strengthened by a holistic promotion encompassing online and offline advertising, social media marketing, word-of-mouth marketing, and celebrity endorsements. With this background, I think the effectiveness of these strategies can be seen in the company’s performance. To demonstrate their effectiveness, the company has surpassed Starbucks in terms of store numbers in China. In June, Luckin Coffee hit 10,000 stores in China, surpassing Starbucks, which operates 6,480. The company has also reported a record-high average monthly transacting customers exceeding 58 million in the third quarter of 2023. The company has also received positive feedback from customers, who appreciate its low prices, convenient delivery and pickup options, and innovative products.

In conclusion, LKNCY has adopted and implemented what I would call a very competitive, effective, and customer-centered marketing strategy, which has paid off and, in my opinion, will continue to propel the company to long-term growth. To demonstrate how effective the strategies have been, I will draw your attention to how the company’s revenue has been trending since 2020 when these strategies started being instituted. In 2020, the company reported a total revenue of $617.88 million, which increased significantly in 2021 and 2022 because of these strategies to $1.25 billion and 1.93 billion in 2021 and 2022, respectively. This implies that the company's revenues have increased by about 212.3% from 2020 to 2022, underscoring the positive impact of these strategies.

The Digitization Milestone: Complimenting Brand Marketing To Achieve Growth

Digitalization has been demonstrated to be a critical factor in modern corporate success . As a result, Luckin has integrated digitization into its business model in various capacities. Through digitization, LKNCY has been able to achieve growth on different fronts, as illustrated below:

Customer retention and financial growth: Through online ordering and store expansion, which is one of the company's digitization efforts, it reached an average monthly transaction record high of more than 58 million in Q3 2023. In addition, the total net revenue was RMB7.2 billion, an increase of 84.9% year on year. The operating margin stood at 13.4%. Meanwhile, the profit margin for self-operated stores was 23.1%, with a 19.9% increase in same-store sales. Underscoring the importance of digitization in the company’s customer and financial growth.

Market share growth: Luckin Coffee has surpassed Starbucks in terms of store numbers and market share in China, becoming the largest coffee chain in the country. The company had about 10,000 stores in China as of September 2023, compared to Starbucks’ 6,480 stores. Its new retail model , which is highly digitized, has helped the company create a mass market for coffee consumption in China and challenge the premium positioning of Starbucks and other rivals. For example, Luckin Coffee operates cashierless stores , which are small and convenient outlets that use smart, cloud-connected kitchen equipment to prepare the orders automatically. Smart equipment and information systems also help the company optimize its inventory management, supply chain, and quality control, leading to a low cost of production and supporting its low-price strategy to beat competitors in price wars.

Using these two examples, it is clear that the company’s digitization efforts complement its brand marketing strategies perfectly, a combination that I believe will sustain its growth in the long run. With these initiatives and given the company’s leading position in China, I am confident that the company’s financial performance will continue to improve in the future as its customer base expands due to the diverse products that address their unique needs and the convenience of getting the products at a lower price.

To support this assertion, I will give the example of Exfreezo . This is a fruit-based coffee that combines the bold taste of coffee with the sweet and juicy taste of fruit for a delightful and refreshing beverage. It is unique since it's made with natural ingredients and has no added sugar, making it a healthier choice for consumers who want to enjoy coffee without compromising their wellness. It is a unique product that its competitors, such as Starbucks, don’t have, making them capitalize on this niche. To show the potential of the product, I will estimate its potential in the market. The fruit-based beverages market in China was worth $ 204 billion in 2022 and is expected to grow at a CAGR of 6.8% from 2022 to 2027. Assuming that Exfreezo can capture 0.1% of this market by 2027, its market size would be $204 billion x 0.001 x 1.068^4 = $283 million. This shows the potential of this company in the market with its unique and innovative products, something which can be further testified by its growing revenues.

Valuation

I will use the relative valuation metric to cover this section, as well as look at a DCF model from Finbox. For the relative valuation metric, I will compare LKNCY to Starbucks. According to the latest financial data, Luckin has a P/E ratio of 30.14, while Starbucks Corp. has a P/E ratio of 28.71. This means that Luckin is trading at about a 5% premium to Starbucks Corp. based on their earnings. However, this premium may not reflect the true value of Luckin Coffee Inc., as it has several advantages over Starbucks Corp. in the Chinese market, such as:

• Faster growth: LKNCY reported an 84.9% increase in net revenues in the MRQ, compared to an 11% increase for Starbucks Corp. in the same period.
• Higher profitability: Luckin achieved a net profit margin of 13.7% in the MRQ, compared to a net profit margin of 13.01% for Starbucks Corp. in the same period.
• Larger network: They had about 10,000 stores in China as of September 30, 2023, compared to about 6,480 stores for Starbucks Corp. This gives LKNCY a wider reach and more convenience for its customers.

Based on these factors, Luckin may deserve a higher P/E ratio than Starbucks Corp., as it has more growth potential, profitability, innovation, and market share in the Chinese coffee industry. Therefore, Luckin Coffee Inc. may be undervalued at its current P/E ratio of 30.27 and could be worth more than its current stock price of $34.79.

To demonstrate the upside potential of this stock is a DCF model by Finbox, which is shown below.

According to the model, the stock has a fair value of $83.13 and an upside potential of about 144%. Given its strong performance in the recent quarter and the excellent strategies in action, I am confident this stock can exploit its upside potential. The company appears to be beating its closest competitor, Starbucks on nearly all fronts, ranging from innovation, growth, and profitability, something I believe should keep driving its share prices up.

Technical Analysis

Based on different indicators, I will cover the technical analysis of this stock in this section. To begin with, the stock is trading at $33.94, above its 50-day and 200-day moving averages of $27.50 and $16.17, respectively. This indicates a bullish trend and a possible uptrend continuation.

Another indicator is the on-balance volume [OBV], which shows that buying pressure has dominated in recent months, as the OBV line has made higher highs in tandem with the price. The accumulation/distribution line also confirms the positive price/volume convergence, indicating that investors are accumulating shares. In addition, the average directional index [ADX] suggests that the uptrend is strong and stable as the ADX line rises and the positive directional indicator (+DI) is above the negative directional indicator (-DI).

Now, let’s look at the oscillators. The relative strength index [RSI] indicates that the stock is not overbought, as the RSI line is at 58.2 and rising, indicating that the bulls are in control, but the shares are not yet overbought, indicating that the stock has room to rise further.

According to this analysis, this stock is on a bullish trend that I believe will continue because its digitization efforts, combined with an excellent marketing strategy, will drive long-term company growth.

Risks

Since any investment has risks, here are some risks of investing in this stock. First off, the risk of legal and regulatory actions and penalties due to the accounting fraud scandal that the company admitted in 2020. The company has been delisted from Nasdaq and fined by the China Securities Regulatory Commission. The company has also filed for bankruptcy protection in the US, which may affect its ability to repay its debt and liabilities. It may face further legal and regulatory challenges in the future, which could harm its reputation and financial performance.

Secondly, there is the risk of failing to sustain its growth and profitability in the long term due to its low-price strategy and high operating costs. The company is currently profitable, but it remains to be seen whether it can maintain its profitability in the future. The company’s low-price strategy may erode its margins and limit its ability to invest in product quality and innovation. With its low pricing, it must move volumes in the market to achieve high revenues to translate to higher and sustainable profits. Should its sales decline for whatever reasons, it could cause a major dent in its bottom line.

Conclusion

Based on this analysis, I am confident that LKNCY will continue to grow exponentially in the future, resulting in more robust fundamentals and stellar share growth. Based on the technical analysis, I recommended the stock to potential investors to capitalize on this growing stock.

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