Luckin Coffee (NASDAQ: LK), the fastest-growing coffee chain in China, went public in May at $19 per share -- and immediately polarized investors. The bulls were impressed by Luckin's rapid expansion and triple-digit revenue growth, but the bears noted that its losses were widening and that it had no viable path toward profitability.
Luckin is challenging Starbucks (NASDAQ: SBUX) by selling cheaper drinks, prioritizing digital payments and deliveries, launching celebrity-backed marketing blitzes, and aggressively increasing its store count. Those pricey strategies caused Luckin to post a net loss of $241 million last year as it generated just $125 million in revenues.
In other words, Luckin lost nearly two dollars for every dollar it made. The situation improved slightly in the first quarter when it posted a net loss of $82 million from $71 million in revenue, but it's still burning through the $651 million it raised from its IPO.
Image source: Getty Images.
Luckin currently operates over 3,000 stores across China and plans to expand to 4,500 stores by the end of the year. That ambitious plan, aimed at eclipsing Starbucks' 3,789 stores in China, could certainly drain Luckin's coffers dry. To make matters worse, Luckin's two latest strategies -- the introduction of a new tea brand and an overseas expansion -- seem desperate and expensive.
Selling more tea
Luckin recently launched a new tea brand called Xiaolu (Little Deer). It initially tested out Xiaolu's tea drinks at a store in Beijing, then green-lit the addition of four Xiaolu beverages to Luckin's online menu. Luckin notes that the tea beverages -- which are blended with fresh fruit, tapioca pearls, and milk -- are generally more popular in the summer than coffee-based drinks.
Speaking to Chinese news outlet 36KR, Luckin co-founder Guo Jinyi stated that the decision was made in response to customer requests for tea drinks. This isn't the first time Luckin diversified its business beyond coffee -- it already sells light meals, juices, and other products at select locations. It also counters Starbucks' recent moves into the Chinese tea market with eight new drinks.
But here's the problem: Luckin's tea drinks cost 25% less than Starbucks' comparable drinks, and it expects its margin for tea to be 25% lower than its margin for coffee. That sounds like a risky strategy for an unprofitable company, and its tea drinks could easily cannibalize its coffee drinks.
Luckin also plans to aggressively promote its tea with free drinks and steep discounts, just as it did with its coffee. However, doing so will likely cause its customer acquisition costs, which decreased significantly in the first quarter ahead of its IPO, to rise again.
Image source: Getty Images.
Expanding into India and the Middle East
Luckin hasn't even hit its expansion target in China, and it's already taking its first steps overseas. Luckin recently announced plans to form a joint venture with Kuwaiti food company Americana Group to open an unspecified number of stores across the Middle East and India.
Americana Group operates 1,900 restaurants in 13 markets, along with 25 food production sites across the UAE, Saudi Arabia, Kuwait, and Egypt. That network could help Luckin reach a lot more customers, but it will likely deploy more loss-leading strategies to promote its drinks -- which will result in even wider losses.
Expansion into the Middle East and India makes strategic sense. Back in 2017, Euromonitor International estimated that the coffee market in the Middle East and Africa would grow at an annual rate of 5% per year to become a $44 billion market by 2021. The coffee market in India grew 7% annually to $928 million in 2019, according to Statista, and could retain that growth rate through 2023.
However, simple math indicates that Luckin should focus on stabilizing its business in China, reducing customer acquisition costs, and narrowing its losses before expanding overseas.
The tortoise and the hare
Luckin is still a rapidly growing company, and it could easily double or triple its revenue this year. But that growth is unsustainable -- the company sells all of its products at a loss, and it's burning through its cash so quickly that it might need to pursue a secondary offering.
Luckin's latest strategies indicate that it doesn't grasp the reality of being a publicly traded company instead of a start-up. Instead, it's charging ahead with loss-leading strategies without any clear idea about how to convert its revenue into profits. In this race, Luckin is the hare, while Starbucks is the tortoise -- and we all know how that story ends.
More From The Motley Fool
- 10 Best Stocks to Buy Today
- The $16,728 Social Security Bonus You Cannot Afford to Miss
- 20 of the Top Stocks to Buy (Including the Two Every Investor Should Own)
- What Is an ETF?
- 5 Recession-Proof Stocks
- How to Beat the Market