Why Investors Should Just Give Up on Luckin Coffee

Stocks to sell

When accusations against Luckin Coffee’s (NASDAQ:LK) accounting of false sales proved true, investors rightfully headed for the exits. LK stock fell from the mid-$20s and settled at $2.16.

The Freeze on LK Stock Isn't Just a Lesson, It's an Opportunity

Source: Keitma / Shutterstock.com

The miniature rallies will not likely have enough momentum to offset investors who bought shares in the $30s and $40s. Still, the company will find a way to stay listed.

LK Stock De-listing

The Nasdaq said that it will de-list Luckin Coffee from its exchange when its former chief executive officer, Jenny Qian, and its former chief operating officer, fabricated ~$310 million worth of sales. It may also have inflated costs.

Keeping its Nasdaq listing seems unlikely with too many unreliable revenue totals and cost figures. This did not stop its shares from bottoming in the $1.40 range last week and topping $2.74 on May 27.

Speculators would get a big payoff if Luckin somehow manages to remain listed on the major exchange. Management would have to present revised figures that auditors sign off. Still, a de-listing would move the listing to the over-the-counter markets. This will severely hurt trading volume. On that exchange, the stock could still increase in value if the company posts improving same-store sales, growing revenue, and smaller losses.

The Hertz Global (NYSE:HTZ) bankruptcy is another example of speculators betting on a better outcome. The stock rallied 87% higher intra-day on May 27. So, if bankruptcy is a more troubling scenario than accounting, speculators would reason that Luckin is not in so bad a situation.

Q3 Reporting Now Meaningless

Luckin’s third-quarter report now looks too good to be true. The company reported a 557.6% year-over-year growth in net revenue and same-store sales profits climbing 12.5%. Flashy presentation slides highlighted branding initiatives, continued investments, and a new spokesperson for the company. Now that investors know sales did not pop as the company previously claimed, they may also infer that promotions did not drive growth.

In January, when much of China locked its businesses down and enforced quarantine, Luckin likely brought in little to no revenue. At that time, the company continued to incur operating expenses. The company had managed to upsize its offering to 9 million American Depository shares (ADs) and 4.8 million ADS offered by the selling shareholder. If it did not get caught, it would have received an injection in cash to keep running the business at a loss.

Luckin had reported a non-GAAP net profit margin of negative 31.9%, an improvement from the negative 1,020.8% net-profit margin in Q1 2018.

Trading or Selling LK Stock

Investors should accept that the company cheated them by making up results. On Wall Street, analysts assigning a $40 price target failed to post an updated view on the company (per tipranks). And on a Stock Rover research report, the site warned of high short bets against the stock. Bankruptcies and accounting fraud are both serious types of risks.

Investors cannot trust Luckin Coffee even after it cleaned up the management team. The company is unlikely to get an accounting firm to review, discover, and correct the massive accounting fraud. The panel meeting with the Nasdaq will happen in 30 to 45 days after Luckin Coffee’s request for a hearing. But to present corrected numbers and to earn the Nasdaq’s trust seems unlikely.

Fair Value and Your Takeaway

Investors have no financial model available to calculate a fair value on the company. Without valid numbers to work with, the stock will trade between 50 cents and $1. For the next few weeks, short-sellers will unwind their position, and shareholders will sell to book the loss. This will create trading volume but the stock will ultimately fall to penny level status.

As of this writing, the author did not hold a position in any of the aforementioned securities. Chris is on twitter and runs the DIY Value Investing Marketplace guide.

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