The coronavirus scare has taken a toll on stocks, and in many cases it’s no surprise. In some cases, however, the fear is exaggerated, revealing more and more green shoots. For example, China’s Luckin Coffee (LK) took a hit in January and February, but there’s reason to believe the concerns are overdone, and the company’s massive gains remain intact. This article provides an overview of Luckin Coffee (which is likely exaggerated, including the recent impact of the coronavirus), the Chinese coffee market, and the company’s technological competitive advantages (Starbucks (SBUX) is Currently trying to emulate Luckin), business operating leverage, valuation and risk. Finally, we give our opinion on investment.
Image Source: Luckin Coffee
overview
Luckin Coffee operates over 4,500 stores across China. Launched in October 2017, the company went public in May 2019. As of December 2019, it serves 40 million customers. As of September 2019, more than 93% of his stores at the company were pickup stores with limited service, and 3% were delivery. “Café-like” sit-down restaurants accounted for only 4% of stores. Luckin has stores in 25 provinces and municipalities in China, with 60% of stores concentrated in Guangdong, Jiangsu, Shanghai, Beijing and Zhejiang.
The impact of the coronavirus is being blown out of proportion
Luckin Coffee reported solid results for the third quarter of 2019, reporting positive store-level profit margins for the first time since the company was founded. Both per pricing have improved. Unsurprisingly, the stock skyrocketed from his $18-19 in November 2019 to about $45 by mid-January 2020. But right after the coronavirus hit China, Luckin fell nearly 25% in the weeks that followed.
Source: Left Brain Investment Research, Yahoo Finance
we do not object, Luckin is most likely going to be ugly in Q1 2020 given the massive quarantine and wavering consumer confidence in the country, but investors are now terrified and We believe the first ‘green shoots’ are occurring at the epicenter of this crisis. Ignored.
A review of the data collected on the spread of the coronavirus by the Center for Systems Science and Engineering at Johns Hopkins University has made it increasingly positive that the crisis may abate. As evident from the graph below, the second derivative of the increase in the number of reported cases in China has slowed dramatically. Moreover, the number of reported recoveries far exceeds the number of deaths, indicating that the coronavirus is not her 21st century version of the plague.
Source: Center for Systems Science and Engineering, Johns Hopkins University
Finally, within China, Luckin Coffee’s exposure to the most problematic regions is limited. Hubei, which accounts for 84% of the country’s COVID-19 cases, has only 4% of Luckin’s stores. Consumer confidence across the country has taken a temporary hit, but the single-digit exposure to the actual epicenter of the crisis in the country mitigates some of the risks.
Source: Luckin Coffee, Xinhua News Agency
Finally, the following comment from Starbucks CEO Kevin Johnson further underscores that the hysteria about the impact of coronavirus is somewhat misplaced. has reopened approximately 85% of its stores.
“We are seeing early signs of recovery in the region as the number of new cases in China slows.”
China’s coffee market is expected to grow strongly
Chinese people traditionally drink tea. In fact, China and India are the largest tea consumers in the world. Coffee is a relatively new phenomenon, as China’s middle class has connected with the coffee-drinking world and inculcated it with a piece of Western culture. We provide growth opportunities. According to Frost & Sullivan, her per capita coffee consumption in China is only 6.2 cups per year in China compared to about 250 cups in Hong Kong and about 279 cups in Japan. In fact, the evolution of the Japanese coffee market provides an important perspective on the potential of coffee in China. In 1963, coffee consumption in Japan was just 13.1 cups per capita for him, but this figure increased by a staggering 221% in 1970, and as mentioned earlier, in 2018 he Reached 279 cups.
Source: Luckin Coffee, Frost & Sullivan
Given the low base effect, the Chinese coffee market grew at a CAGR of 26% between 2013 and 2018, according to Frost & Sullivan. It is worth noting that while the overall market is growing at a healthy clip, it is the fresh coffee segment of the market that is growing at a faster pace and taking share away from the instant coffee segment. Important. China’s coffee market is dominated by instant coffee, but freshly brewed coffee will account for more than 50% of all coffee cups consumed in China, compared to 25% in 2018. expected. Luckin Coffee is positioned in one of the fastest growing segments. About the Chinese coffee market.
Source: Luckin Coffee, Frost & Sullivan
Democratizing the Chinese coffee market
Starbucks entered China in the 1990s with a focus on the premium segment of the market. While the entry of Starbucks has clearly marked the coffee trend in China, Luckin’s approach to the mass market has helped boost the penetration of coffee in China by offering affordable alternatives to Starbucks. promoting. According to Luckin’s latest quarterly report, the company’s average selling price (ASP) per product (coffee and food) is about 11.2 RMB (about 1.6 RMB) compared to about 30 RMB (about $4) for Starbucks. dollar).
In addition, another key value proposition for Luckin is its no-frills, small takeout-only store format, which opens up more real estate opportunities. His “pickup” stores, which make up more than 90% of the company’s stores, measure just 20-30 square meters and cater mostly to take-out and delivery orders. With less capital investment per store, the company is able to offer coffee at lower prices and spread it more widely.
Technology-enabled operations are a key competitive advantage
Focused on bringing affordable coffee to the mass market, Luckin focuses on using technology to lower the cost of serving customers. Luckin’s customers can only order from the company’s mobile his app, and most if not all customers use the app itself to pay for their coffee. Customers place orders through mobile apps, walk into stores to pick up their orders, avoid queues, or have their coffee delivered. This not only increases productivity in the store, but also provides customers with a more seamless experience. Luckin’s technology-enabled business model has clearly influenced Starbucks. In fact, Starbucks acknowledged increased competitive activity in China at a recent investor conference.
“As I said before, our success has proven the attractiveness of the category and has created a lot of competition. It’s intensifying, it’s growing, and it’s affecting us.”
– Patrick J. Grismer, CFO Starbucks
With Luckin’s success, Starbucks has evolved its own strategy in China. Starbucks introduced his mobile Order & Pay in May 2019, and also launched a new store concept for pickup and delivery orders called “Starbucks Now.” Starbucks’ domestic transformation of its own business model is a testament to Luckin’s relevance and endurance.
Luckin is pushing the boundaries of technology by introducing the ‘Express’ concept, which is essentially an unmanned coffee machine fully integrated with the company’s tech backbone and equipped with features such as IoT and big data.
Slowly but surely we are seeing operating leverage
As Luckin Coffee adds more locations and improves store sales productivity, the company’s sales force is beginning to emerge. The cost per cup of coffee decreased from RMB 16.4 in Q3 2018 to RMB 9.7 in Q3 2019. The decrease in cost per cup of coffee was primarily due to an increase in the number of items sold per store, from 109 in Q1 2018 to 444. There was no commensurate increase in store rents or other fixed costs in the third quarter of 2019.
However, the company was also able to control variable costs, as evidenced by a 21.3% drop in material costs from RMB 6.1 to RMB 4.8 per cup. Unsurprisingly, economies of scale and increased purchasing power resulted in store-level margins being in positive territory for the first time since Q3 2019.
Reasonable valuation considering future growth
The stock trades at 2.4x 2021 sales and 16x 2021 EBITDA. Given the nascent stage of China’s coffee market and the company’s strong position and technology-driven competitive advantage in the mass market coffee segment, the valuation fails to incorporate Luckin’s addressable market and growth opportunities. thinking about.
risk
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Spread of COVID-19 infection. The coronavirus outbreak shows signs of stabilizing, but stocks could come under further pressure if the outbreak escalates again in China.
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Increased competitive activity. Given the attractiveness of the Chinese coffee market, new entrants may enter the space, and existing players, including Starbucks, may resort to discounts/coupons. This could put pressure on Luckin’s competitive position and its ability to increase productivity and improve profitability.
Conclusion
Luckin Coffee is a disruptive force in China’s coffee industry. Bringing coffee culture to the mass market. The company is rolling out its network of stores at a very healthy pace, using technology to reduce costs (and investing savings in driving traffic and improving profit margins). The coronavirus scare is Luckin (another example is Meituan-Dianping (OTCPK:MPNGF), a single-app platform for food delivery, hotel travel, etc. See the company’s full report here). Overall, we believe Luckin Coffee offers investors an impressive multi-year growth opportunity. Clearly, despite the coronavirus fears and volatility, Luckin stock has tremendous upside potential.
