Luckin Brews Up Hot Results on Rapid Expansion, Diversified Footprint

China’s leading coffee chain’s revenue rose 72% in the second quarter, even as most of its peers reported declines due to Covid-related disruptions

Key Takeaways:

• Luckin Coffee reported strong revenue and profit growth in the second quarter, banking on a rapid expansion and winding down of expenses related to an earlier accounting scandal
• Company has adopted a hybrid model of using self-operated stores in major cities, while working with partners to open stores in smaller markets

By Doug Young

Chinese restaurants and coffee shops got hammered in the second quarter, as widespread Covid controls, including a two-month citywide lockdown in Shanghai, wreaked havoc on their business. But you would never know that from the latest results of Luckin Coffee Inc. (LKNCY.US), the country’s largest coffee chain that has come roaring back from a massive scandal that nearly shut it down two years ago.

The skeptics might be slightly dubious about Luckin’s latest results published on Monday, which show its revenue jumped 72% in the quarter year-on-year to 3.3 billion yuan ($489 million). After all, this was a company that made global headlines just two years ago when it admitted to fabricating nearly that amount – or 2.2 billion yuan – in sales in 2019.

The huge second-quarter sales gain was all the more impressive when one considers that most other Chinese chains reported big revenue declines for the quarter due to all the pandemic-related disruptions. A case in point is Yum China (YUMC.US), operator of KFC and Pizza Hut stores in China, which reported a 13% revenue decline for the quarter.

Luckin is admittedly under the microscope these days after its 2020 scandal, which perhaps is why investors seem to be buying into its comeback story. The company’s stock jumped 12% the day the results came out, and is now up more than 50% this year – something not many companies can say. What’s more, the shares now trade at a post-scandal high, and at their latest close of nearly $15 are fast approaching the $17 mark that was their 2019 IPO price.

With a market value of nearly $4 billion after its stock run-up, the company now trades on a roughly equal basis with the other restaurant big boys. Its price-to-earnings (P/E) ratio now stands at 28, which is actually ahead of the 24 for top rival Starbucks (SBUX.US) and is also ahead of the 27 times for Yum China. So clearly the company is getting growing respect from investors, even as its shares remain traded over-the-counter after getting kicked off the Nasdaq, post-scandal.

So, how exactly has Luckin gone from poster child for bad business practices to head of the class on China’s booming coffee scene? And by head of the class, we really do mean the clear leader in China’s coffee market with 7,195 stores at the end of June, well ahead of No. 2 Starbucks at 5,761 stores at the end of July.

The answer to that question appears to be its successful brew combining small stores that are easy to open and cheap to run, with a diverse strategy that relies not only on major wealthy metropolises like Beijing and Shanghai, but also on smaller cities. That big-city reliance was a major Achilles heel for other big names like Starbucks in the second quarter, since most of the worst Covid disruptions occurred in such major cities during that period.

Potent partnerships

Founded in 2017, Luckin quickly became a major player on China’s coffee scene with its focus on low-cost premium coffee served mostly from the kinds of small, minimalist stores we described above, mostly for takeout consumption. The company also kept labor costs down with its app-only ordering, allowing it to staff stores often with just a couple of people at a time. That formula has been copied by many others, and Starbucks even launched a new similar format, called Starbucks Now, just for the China market.

While the small, low-cost format is old news for Luckin, a newer element to its success is its adoption of a hybrid formula combining self-operated and partnership stores. The former type focus on bigger, more profitable first-tier cities, while the latter focus on smaller markets where local knowledge and experience is more important.

Of the company’s 7,195 stores at the end of June, nearly 70% were self-operated. But revenue from self-operated stores accounted for 76% of the company’s total, showing that the big-city stores it self-operates bring in more revenue than their smaller-city counterparts. The latest ratio of self-operated stores was down from a year ago, when 76% of Luckin’s stores were self-operated, showing it is adding new partnership stores faster than self-operated ones.

Luckin’s self-operated stores posted same-store sales growth of 41.2% for the quarter, a number that’s already quite strong but becomes even more impressive when one considers that Starbucks same-store sales in China tumbled 44% year-on-year in its latest quarter through July.

The bottom line was that Luckin reported a second-quarter net loss of 114.7 million yuan, largely because that includes a 276.8 million yuan provision for litigation costs related to the scandal. Excluding that and some other non-operating items, the company reported a non-GAAP profit of 267.5 million yuan for the quarter, roughly triple the 92 million yuan profit a year earlier.

We’ll wrap things up with a look at lingering scandal-related issues, which are one of the major obstacles preventing the company from upgrading its over-the-counter status to resume trading on the main board of the Nasdaq.

“I am pleased to announce that, after the successful completion of the restructuring of our financial indebtedness in the first quarter, we have made substantial progress on resolving outstanding U.S. securities litigation (issues),” Chairman Guo Jinyi said in remarks accompanying the results. “We received final court approval for the federal class settlement and we also made substantial progress in resolving remaining … litigations. This marks another important milestone for Luckin Coffee in resolving all of its historical issues.”

Reflecting the wind-down of those “historical issues,” Luckin reported its losses related to the scandal and subsequent company restructuring totaled a relatively modest 20.6 million in the second quarter, down from 62.9 million yuan a year earlier. The company didn’t say too much on if and when it might apply to return to the Nasdaq main board, though its executives said on its earnings conference call it remains “committed to U.S. capital markets.”

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