Starbucks v Luckin Coffee: which share price to back as fight for China ensues?

Since being founded a few years ago, Luckin Coffee has quickly expanded to become the second biggest coffee chain in China. Number one is Starbucks, which opened its first Chinese coffee shop in Beijing 20 years ago. But Luckin Coffee has its sights firmly set on overtaking the Seattle-based giant. So, which share price is the best bet? And is one stock better value?

How Luckin Coffee’s share price compares to Starbucks?

Luckin Coffee’s share price has soared 43% since the company IPO’d in mid-May, far outpacing Starbucks’ 8.83% gains in the same time frame.

Yet, while Luckin has seen its revenues grow, losses are also on the rise. This may be unsurprising, given that the company is still in high-growth mode, but analysts are now asking just how sustainable this is for both the business and Luckin Coffee’s share price.

Can Luckin Coffee really overtake Starbucks in China?

During its Q3 earnings call, Luckin Coffee’s Chief Financial Officer Reinout Schakel said it will “take over Starbucks as the No.1 coffee player in China by the end of this year”.

Stealing Starbucks’ crown is a tall order. The Seattle-based company commands a dominant 50% market share, while Luckin Coffee managed to claim just 2.1% of the Chinese market last year.

To beat Starbucks, Luckin has opened an average of nine stores a day for the past year, aiming to match Starbucks’ 4260 locations. But Starbucks isn't taking this lying down, and plans to open a store every 15 hours in China.

How has Luckin Coffee performed in Q3?

Luckin coffee’s share price got a further 14% boost following quarterly numbers that beat analyst expectations.

Since its market debut, Luckin has updated the market twice. In its most recent set of quarterly numbers, the coffee chain revealed that it had opened 717 new stores in the three months ending 3 September.

Bumper revenues of 1.54 billion yuan easily beat analyst expectations of 1.47 billion. However, Luckin's net losses widened to 531.9 million yuan from 484.9 million yuan seen the same time last year due to the cost of opening more stores. 

Driving revenue was Luckin Coffee’s targeting of China’s tea drinkers. In the results, tea constituted 20% of freshly brewed drink sales. During the quarter, Luckin Coffee added 8 million new customers which was “partly driven by the success of Luckin Tea products” according to Schakel.

For the fourth quarter, Luckin has guided for 2.1 billion yuan to 2.2 billion yuan in net revenue, topping the $289.08 forecast by analysts.

How big is the potential in China?

Traditionally China has been a tea drinking nation, but its appetite for coffee is growing. According to Euromonitor data, the Chinese coffee market was worth $5.8 billion last year, up from $2.7 billion in 2014. In the long-term, the market is expected to grow annually by 11.3% CAGR until 2023.

China's growing middle-class and increased disposable income has led to the shift in drinking habits. Luckin Coffee focuses on convenience and affordability, with orders made on an app before pick up. This makes it a popular choice for white-collar office workers, who prefer a quick fix over Starbucks’ premium sit-down restaurants.

Luckin Coffee’s extensive tea line-up also makes it stand out compared to rivals. In 2015 626,261 metric tons of tea were consumed in China, compared to 67,487 metric tons of coffee, according to data from Statista. With tea still the nation’s favourite drink, especially outside the large metropolitan areas, Luckin could have an edge over Starbucks.

How do the two stocks stack up?

Luckin Coffee’s 540.2% quarterly revenue growth is certainly impressive. However, a -71.70% profit margin is difficult to ignore. Starbucks’ 7% revenue growth and 13.58% profit margin reflect a more mature company, which could have the financial might to fend off its upstart rival.

Luckin Coffee & Starbucks share price vitals, Yahoo finance, 18 November 2019

If Luckin Coffee is to avoid being burned by overexpansion, then it has to get costs under control. There are signs that this is happening, with costs coming in lower than expected. 

According to Ben Cavender, managing director at China Market Research Group:

“It is a good sign that expenses are falling. But the question will be how much farther they can push them down and if they can make individual stores more profitable.”

Among the analysts, Luckin Coffee has an average share price target of $26.2, which is 3% below its current price. Starbucks has an average price target of $94.58, which would represent a 13% upside on the current share price.