Luckin Coffee's [LK] share price has plummeted in the wake of one of the biggest financial fraud cases in history. Since then, boardroom shakeups and being delisted from the Nasdaq have seen things go from bad to worse.
Given that Luckin Coffee's share price is down nearly 94% this year to date, the shares could be a bargain if the coffee chain manages to turn things around. Such a recovery is a big ask, though, and investors will need to think carefully before taking a chance on the stock.
We look at what happened to the chain, the impact its decline has had on other Chinese companies, and whether there really is any prospect of an upside in Luckin Coffee’s share price.
Luckin Coffee's YTD share price drop
Luckin Coffee’s rise to the top
Luckin Coffee came from nowhere to dominate the Chinese coffee market in a few short years. Usurping Starbucks, the chain listed more than 6500 locations throughout China in its app store locator in April 2020.
Luckin Coffee used steep discounts and freebies to fuel its rapid expansion plans. When it listed on the Nasdaq in May 2019, Luckin Coffee’s share price was $20.38 and the company raised $561m as US investors flocked to back the mega growth story.
So, what caused Luckin Coffee’s share price to go from its all-time high of $51.38 to a Nasdaq delisting in the space of six months?
A report from Muddy Waters Research claimed Luckin Coffee had inflated its volume of sales by 69% in Q3 and 88% in Q4. In July, this malpractice was confirmed by an investigation conducted by China's Ministry of Finance.
The investigation found that Luckin had fabricated sales of CNY2.25bn and revenue of CNY2.12bn. Investors couldn’t get rid of the stock fast enough, and the scandal led to Luckin Coffee being delisted from the Nasdaq.
Valuation of Luckin Coffee's fabricated sales
Luckin Coffee's saga has had widespread repercussions for Chinese companies looking to the US for investment. In May, the US Senate approved a bill that requires Chinese companies to be scrutinised by the Public Company Accounting Oversight Board. Companies from China and other countries that do not comply with accounting standards will be delisted from US exchanges by the end of 2021.
The saga also "refreshes the story that Chinese equities are dangerous,” according to Paul Gillis from the Peking University’s Guanghua School of Management speaking to Bloomberg.
These prejudices have gained traction in recent weeks, with US President Donald Trump giving TikTok — a social media platform owned by China's ByteDance — an ultimatum between selling its US operations or being banned from operating in the country.
In the run up to the US Presidential election, the Trump administration could well come down harder on Chinese companies, adjusting what it sees as imbalances between the countries’ economies. Such political intervention will increase the perceived risks for investors putting their money into Chinese firms.
For those willing to stomach the risk, Luckin Coffee's share price could represent something of a bargain right now. Having started the year trading around $40 a share, the stock closed Friday at $2.12 — a massive 95% decline. If the coffee chain is able to ride out the upcoming headwinds, which are significant, investors could gain even if Luckin Coffee’s share price does not fully recover.
That said, the potential for Luckin Coffee’s share price to see an upside is questionable. The South China Morning Post has reported that China's State Administration for Market Regulation is planning to penalise Luckin for its misconduct. The Ministry of Finance is also planning to take action against the company.
A further limit to Luckin Coffee’s share price potential is the ongoing boardroom disruption, which is regularly finding its way into the financial press. Last week, news broke that two directors — Jie Yang and Ying Zeng — had tendered their resignations from Luckin's board.
The two had only been in their positions since 5 July, the same day Sean Shao was booted out as director. Rumours now abound regarding Shao’s possible reinstatement at an extraordinary general meeting in early September.
Investors — even bargain hunters — should seriously consider this ongoing turbulence before backing the company, no matter how low Luckin Coffee’s share price gets.