Luckin Coffee Inc. (OTC: LKNCY) continues to brew a comeback that was unthinkable just two years ago, selling lattes like hotcakes across a rapidly expanding store network that has passed Starbucks (NASDAQ: SBUX) to become China's largest.
Last week, Luckin reported its total net revenue surged 85% year-on-year to 4.4 billion yuan ($646 million) in the first quarter. Such rapid revenue growth in China's crowded coffee market is impressive in itself. But even more remarkably, the company's net profit soared nearly 30-fold to 565 million yuan in the first three months of the year from a year earlier.
The results show that Luckin, founded in 2017 as a Starbucks challenger, is staying firmly on a turnaround track three years after its admission to $300 million in fabricated sales pushed the company to near-collapse. Luckin was hit with a shareholder class action lawsuit and large fine from the U.S. securities regulator for the scandal, and was kicked off the Nasdaq in the middle of 2020, just about a year after its IPO.
Settling all its legal and regulatory problems has proved costly, to say the least. But a new management team has righted the ship rather quickly to focus on a capital-light franchising strategy to grow its wide network of blue-and-white stores featuring its trademark deer profile. The company continued to incur some lingering scandal-related costs in the first quarter. But those costs decreased substantially, suggesting the episode that made Luckin a poster child for China's sometimes fast-and-loose accounting practices is largely history now.
With the headaches now rapidly fading from view, Luckin is in full-on expansion mode to solidify its leadership in China's increasingly crowded coffee market. The company opened more than 1,100 new shops in the first quarter to boost its total to more than 9,300, including about 3,000 franchised outlets, at the end of March. The latest count was up 14% from the end of last year.
That figure translates to Luckin adding a new shop every 1.9 hours during the January-March period. The rapid expansion is keeping the company well ahead of Starbucks, which had about 6,200 stores in China as of April 2, making it the country's second largest chain, according to the U.S. coffee giant's latest quarterly results.
Starbucks also lagged far behind Luckin in top-line growth in China in its fiscal quarter to April 2, with its sales up just 3% year-on year. Notably, however, Starbucks maintained a larger China revenue base that is approaching $800 million on a quarterly basis, which shows that Luckin's franchise-focused model is good at brewing up new store openings but less potent at creating new revenue.
Among other things, Luckin attributed its strong first-quarter performance to the popularity of specialty products like its coconut latte, whose sales have surpassed 300 million cups since it was introduced two years ago, as well as other new products.
Controlling Costs
Luckin's main strength lies in its business model that enables it to be profitable by strictly controlling costs, even though it charges far less for its products than more premium brands like Starbucks. Key among its cost controls is the company's app-only ordering system. It also keeps down rental costs by using a minimalist format for its stores, which mostly have little or no seating and don't require large spaces. And, of course, Luckin's growing use of franchised stores requires far less capital than running its own outlets.
The company's rapid expansion will give it the scale to make it even more efficient. Its operating profit margin stood at 15.3% in the latest quarter, on par with Starbucks, and up from a tiny 0.7% in the first quarter of 2022, when all retail businesses in China suffered from lockdowns and other restrictions as Beijing was still implementing strict Covid-control measures.
As its home market heats up with a growing number of both foreign and domestic homegrown rivals, Luckin is also branching out of China. It opened its first two stores in Singapore during the first quarter, which marks a pretty significant milestone for the company.
"The launch of Luckin Coffee's Singapore stores is an important first step in our expansion into international markets and is the starting point of our internationalization strategy," said Chairman Guo Jinyi in remarks accompanying the company's earnings announcement. "By establishing a presence in Singapore, we are aiming to fine-tune our entire IT and operation system for this expansion, and test our business model in the overseas markets.
Overseas expansion makes sense for Luckin as its increasingly competitive home market will inevitably become saturated eventually.
One interesting - and potentially formidable - recent new rival for Luckin is Cotti Coffee, which was created last year by Luckin's own two founders after they were forced out of the company following the accounting scandal. The two, Charles Lu and Jenny Qian, obviously know a thing or two about how Luckin operates, and they aren't wasting time in trying to replicate the successful formula of their former startup.
Cotti has already opened well over 1,000 outlets since its launch last October, and aims to have 10,000 stores by the end of 2025. Its rapid expansion isn't the only similarity to Luckin, with Cotti also focused on value for money and convenience. But at this point, it has a long way to catch up with Luckin, which is likely to continue with its own runaway expansion.
Despite the glossy first-quarter results, Luckin shares, which only trade over-the-counter in New York, slipped most of last week. But they have soared from the depths they reached during the crisis, including a tripling over the last year, and are now some 26% higher than their IPO price. The stock now trades at a price-to-earnings (P/E) ratio of more than 45, compared to 35 for Starbucks.
That strong valuation suggests a lot of optimism is brewing around Luckin's turnaround despite its scandal-tainted past and potential challenge from a fast-rising new clone on the block. And it's not hard to see why, given what the company is producing, not just popular lattes but also flavorful financial results.