Chinese coffee chain Luckin Coffee (OTC:), a company with negative margins, shouldn’t be trading at a higher multiple than Starbucks (NASDAQ:), according to Quo Vadis president John Zolidis.

This stock is a bear market. (See Luckin Coffee stock charts on TipRanks)

Disconnect between Market Valuation and Fundamentals

Zolidis, who sounded the alarm early about the ailing chain’s woes, made this comment following LKNCY’s filing of a 10k for 2020 and settling of various lawsuits. At the same time, the company did not provide any quarterly P&Ls.

“The bottom-line is that LKNCY is currently valued by the market at $5B, which is roughly 5x our 2022 revenue estimate,” Zolidis said. “This is despite the fact that 2020 EBITDA margins were negative 39%. Even taking the top quarter in 2020, we still expect a negative EBITDA margin and a RLM below 1%. Also worth noting, LKNCY burned through $1.1B of fraudulently acquired funds in 2019 and 2020.”

Luckin has no analyst following on Wall Street. TipRanks rates the company with a Smart Score 5. This is due to decreased hedge fund activity as well as low investor and blogger sentiment and a dearth of basic and insider information.

TipRanks points out the increasing risks to the company. TipRanks has listed 101 possible risk factors.

A Change in Strategy

For years, the Beijing-based coffee chain was opening coffee shops at a feverish pace, trying to match and surpass industry leader Starbucks.

Both companies operate different types of stores. Starbucks’ store concept is the “third place,” a comfortable place where people can enjoy mixed espresso drinks with friends and associates away from home and work. The store environment makes it possible to charge higher prices for Starbucks products and still be profitable.

Luckin’s store concept is “coffee to go,” where people can pick up coffee. This makes it impossible to charge premium prices and still be profitable. That’s at the root of the company’s woes.

Its leadership decided to close down the worst performing stores and cut back on promotions in order to turn around. While this is the right strategy, Zolidis thinks it won’t work. “Customer transactions fell at a double-digit rate every quarter in 2020,” he says. “Has this continued into 2021? Covid is probably not helping a business that chose to put most locations in office towers.“

While he thinks that Luckin’s strategy won’t work, he’s still concerned about the company’s valuation going forward. His model suggests that Luckin gets a positive EBITDA by 2023, but he thinks it doesn’t make sense for a business with this financial profile to trade at a higher multiple than Starbucks or Shake Shack (NYSE:).

Bottom Line

In short, Luckin is a money-losing coffee chain with a high market valuation in search of a strategy for its survival. It is important to remember that hype cannot replace due diligence when investors are trying to chase its shares.

Disclosure: Panos Mourdoukoutas did not hold any position in Luckin Coffee at the time this article was published.

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