Avoid Tarnished Luckin Coffee With Shares Bound to Head Lower

Stocks to sell

Earlier this year, Luckin Coffee (NASDAQ:LK) stock was one of the hottest names out there. The coffee chain, touted as China’s answer to Starbucks (NASDAQ:SBUX), looked like a solid long-term growth story. But in April, shares tumbled. With an investigation over accounting fraud, investors bailed, sending shares down nearly 76% in one day. Soon after that, Nasdaq halted trading of the company’s stock.

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Shares resumed trading last month, initially taking another 35% dip. Then, it fell to prices as low as $1.33 per share. Yet, so far this month, investors have ignored the big red flag (accounting fraud), and have dived back into the stock. Since June 1, shares have rallied from around $2 per share to just under $4 per share. And that’s after reaching prices above $6 per share on June 5.

Simply put, this recent run-up is not indicative of a “turnaround” for this tarnished company. As InvestorPlace’s Mark Hake wrote June 9, the recent rally is largely due to short-sellers covering their positions. Once this short-squeeze ends, expect shares to fall back to prior lows.

In short, don’t get fear of missing out and buy into this company. With its growth story derailed, and reputation tarnished, expect shares to trek lower over the next few months.

Why LK Stock Could Go Lower From Here

Shares may have fallen more than 90% below their all-time highs. But that doesn’t mean bad times are over just yet for LK stock. Why? With the company’s 2019 revenue numbers found to be fraudulent, who’s to believe any financial results from this company going forward?

Sure, the company has “cleaned house,” and Luckin’s former chairman is now facing criminal charges. But this is all too little, too late. Without any trust in the company’s financial statements, there’s no reasonable way to determine its underlying value. Forget about “overvalued” or “undervalued.” For now, the company’s value is a big question mark.

In short, investors buying shares now are essentially buying a lottery ticket. If the company manages to ride out this scandal, shares could bounce higher, albeit far below where they were before the scandal broke.

But, more likely, the stock is headed towards penny stock status. Why? It’s likely to be delisted from the Nasdaq permanently. Once that happens, shares could, in theory, trade on the over-the-counter (OTC) market. Yet, with institutional and retail investors typically avoiding OTC stocks, demand for shares is going to take a big hit.

Granted, the Nasdaq delisting is still pending. Luckin has requested a hearing before an exchange panel. This panel has 30 to 45 days after the request to convene. With the company pursuing this “Hail Mary” in mid-May, that means in just a few weeks we’ll know whether shares continue to trade on a major exchange.

This may also explain why shares haven’t cratered just yet. But, with the odds firmly against LK stock, buying now on the hopes its Nasdaq listing continues looking like a gamble not worth taking.

Don’t Bet on a Surprise from Luckin Coffee

Chances are LK stock falls to even lower prices than where it is today. Yet, there is still a slight chance the company rides out this scandal, and retains some value. As our own Ian Bezek wrote June 10, with the company’s secondary offering earlier this year, they may still have plenty of liquidity. While prior sales figures were inflated, they still have a substantial presence, and generate hundreds of millions in sales.

Now, don’t take that to mean Luckin still has a shot at unseating Starbucks as China’s most popular coffee chain. What I’m saying is, there’s still a chance the company can pick up the pieces, and turn what’s left into a profitable business.

But, this still isn’t enough to go out and buy this stock today. The risk/return proposition remains out of your favor. Until we see revised financials, we remain in the dark. For now, it’s still uncertain whether shares today price in a turnaround, or if they trade far below their potential value if a full recovery happens.

Forget About Buy, Sell, or Hold, LK Stock Is an ‘Avoid’

Speculators may have made easy money trading this stock as of late. But, don’t take that to mean this is a screaming buy. At any price. With the big red flag of fraud tarnishing their reputation, there’s no good reason to buy Luckin Coffee’s stock right now.

Firstly, due to the risk of delisting. If shares no longer trade on the Nasdaq, expect them to fall to much lower prices. Secondly, even if the company manages to bounce back from this scandal and become a profitable business, we don’t know whether today’s stock price reflects this upside potential or not.

In short, there’s still a lot to lose, and little to gain, with LK stock. Forget about “buy,” “sell” or “hold.” This stock is an “avoid,” pure and simple.

Thomas Niel, contributor to InvestorPlace, has written single-stock analysis since 2016. As of this writing, Thomas Niel did not hold a position in any of the aforementioned securities.

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