Apr 21, 2020

LUCKIN COFFEE (NASDAQ: LK) 

 

Overnight on April 6, Luckin Coffee (NASDAQ: LK) shocked investors with a statement declaring that a special committee formed to oversee an internal investigation had found leading evidence of significant fraud perpetrated by its COO Jian Liu and certain employees last year. Luckin Coffee's stock is down more than 70% on this news. Trading has been suspended on this stock until further notice but keep your eye on it!

 

I bought this at 34.00 a share and today it is at around $4.50. It took a massive drop around the time  the pandemic hit hard. It is a risk but if they get back on their feet and I trust they will, there is a great opportunity here. 

 

China is the most populous country in the world. With many of its 1.4 billion residents hungry for the lifestyle that those in Western economies take for granted, U.S. companies have successfully imported products into Chinese markets, and now entrepreneurs there are also answering the call.

 

Although Luckin Coffee (NASDAQ: LK) is only about two years old, it's already surpassed the size of Starbucks' (NASDAQ: SBUX) store network in that country — and it's just getting started. Even as fears about the COVID-19 outbreak and its worldwide impact have gotten more serious, the long-term prospects for Luckin to dominate the fast-growing coffee market in China are too attractive to ignore.

 

The Big-Picture Opportunity

 

U.S. investors have long recognized the opportunities in the Chinese consumer market. Early movers like Yum! Brands (NYSE: YUM) were highly successful in transplanting popular Western consumer offerings to China. Starbucks similarly saw substantial potential in bringing coffeehouse culture to the world's second-largest economy, plotting an ambitious growth strategy that would double the number of its stores in China between 2016 and 2021. 

 

Right now, the average person in mainland China drinks just six cups of coffee every year. That's up from just 3.2 cups per person per year in 2013, and demand is rising at eight times the global average. To put it in perspective, the average American drinks 388 cups per year, and annual consumption in Japan and Hong Kong works out to 279 and 250 cups per person, respectively. In addition, the retail market for coffee in China will likely more than triple from 2018's $8 billion in annual sales to about $26 billion by 2023. An opportunistic coffee company, therefore, has a considerable chance to corner China's coffee industry.

 

Why Luckin Coffee?

 

Luckin Coffee understands just how underdeveloped China's coffee market is, and it's put together an even more ambitious growth strategy than Starbucks to try to tap into it. Back in 2019, shortly after Luckin's U.S. IPO, CEO Jenny Qian said the company would have 10,000 stores in operation by 2021. Already, it has served more than 40 million customers, and topped the 4,500-store mark as of the end of 2019, surpassing Starbucks as the largest coffee chain in China.

 

Don't get the wrong idea about Luckin, though: It's not on a collision course with Seattle's finest. Luckin is grounded in technology, with customers ordering and paying for their coffee through the company's proprietary mobile app. The vast majority of Luckin locations are tiny pickup-only kiosks inside office buildings, and focus solely on maximizing throughput and getting customers their food and beverages as efficiently as possible. Only a small fraction of cafe-style locations offer a similar experience to Starbucks, and even there, Luckin's primary goal is to gather data it can use to determine an optimal expansion strategy to deliver coffee to as many future customers as possible. Thanks to its app, Luckin knows each customer's order history and can tailor promotions and make menu suggestions based on individual preferences.

 

Why We Trust Leadership

Qian's background is in the auto rental and ride-hailing field, so her experience is in using automation and data analytics to bring a technology orientation to a consumer-facing business. Along with co-founder Charles Lu, Qian has leveraged the power of app-driven technology to tap into the booming coffee market at a perfect time. 

 

Both Qian and Lu also remain financially committed to Luckin. Qian's family trust holds a 15% stake in the company, while Lu's family trust ultimately controls shares that amount to about 24% of Luckin's value. 

 

Why Now?

Now might sound like exactly the wrong time to look at Luckin, given the impact that the spread of the coronavirus has had on its core market. But with signs that the outbreak is coming under control in China, Luckin doesn't anticipate a long-term impact on its growth, and it's made no changes to its 2021 outlook. 

 

Within China, Luckin is in prime position to benefit from several favorable trends. Growing consumer wealth has more people interested in improving their standard of living, and that's feeding a growing coffee craze. The Chinese government supports the idea that domestic companies can replace foreign businesses in key industries, giving Luckin a key home-field advantage against the rise of Starbucks. Luckin's modest operations and rising levels of automation are helping minimize its costs, boosting margins. 

 

Luckin has also indicated its readiness to expand beyond China. A new joint venture will launch a retail coffee business in the Middle East and India, bringing Luckin's high-tech order management platform to a brand-new set of markets. If the concept works well there, the whole world could see Luckin locations pop up quickly, given the minimal infrastructure needed for its stores.

 

Potential Business Risks

 

We can't emphasize enough, however, just how painful the short term could be for Luckin. Major quarantines throughout much of China could make first-quarter earnings numbers look ugly, and Luckin expects revenue at roughly half its target for the quarter. The company hopes that life will get back to normal over the next couple of months, but it could take three or four months in the areas closer to the epicenters of the COVID-19 outbreak. Luckin still sees itself reaching the breakeven mark by the third quarter, but any bad news on the health front could push that date back. If that happens, then you'll appreciate having a diversified portfolio that includes a wide variety of different stocks, because the possibility that Luckin shares could lose 50% or more of their value in a short period of time is higher than it would be for a typical stock.

 

Luckin also faces the threat of competition. Starbucks recently partnered with Chinese e-commerce giant Alibaba Group Holdings (NYSE: BABA) to offer a new delivery service, and although Luckin's target customer is somewhat different from Starbucks', the two are still serving the same broader market. Luckin's success might also prompt copycat operations that could eat into market share.

 

Despite the heightened risks associated with China right now, Luckin Coffee's position in the fast-growing Chinese coffee industry has immense potential rewards for shareholders that justify those risks. As long as the company continues on the path to profitability and manages to weather the temporary disruptions from the coronavirus, Luckin Coffee's spirit of innovation and ambitious growth plans make it the player to watch among China's highest-growth stocks.

 

 

Zynga (NASDAQ: ZNGA)

 

This is around $10 a share and it's another great opportunity, as people may be forced to stay inside for a long, long time, thus opening up opportunities in the gaming market. It has been less than a year since Zynga (NASDAQ: ZNGA) entered the Foolish universe. Now might be the perfect time to pick up some shares. Almost all of those positions are in the red, and not because of any problem intrinsic to Zynga.

 

In early February, Zynga released its 2019 fiscal results, and they were outstanding. Full-year revenue of $1.32 billion was up 46% versus 2018, and sales of virtual goods to players (aka bookings) of $1.56 billion were up 61% year over year. International revenue was up 58% year over year.

 

In 2019, Zynga released two new games: puzzle adventure game Merge Magic! and Game of Thrones Slots Casino. On March 5, the company announced the limited release of the much-anticipated Harry Potter: Puzzles & Spells, a match-three mobile game. Two additional games, Puzzle Combat and FarmVille 3, are being evaluated in test markets and are expected to be released to a wider audience later this year.

 

 

If you find yourself with a little time on your hands, it's easy enough to check out a Zynga game — like Merge Dragons!, CSR Racing, or Words With Friends — from the safety and comfort of your couch. Mobile gaming is growing in popularity, and the rollout of 5G will bring even more opportunity to Zynga. Its expected 2020 addressable market spans 2.5 billion potential players in 155 countries. We don't know when the current stock market volatility will abate, but with $1.54 billion in cash, one can expect that Zynga will be just fine.

 

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