Luckin Coffee Faces Tests as Chinese Economy Could Dramatically Weaken

Stocks to sell

Over the past week, major Chinese equity benchmarks, such as the FTSE China 50 Index and the MSCI China Index, have been doing markedly less poor than the S&P 500 as the coronavirus from China has stabilized somewhat in the region while spreading to other countries. But less bad doesn’t mean good. The Chinese economy is nowhere close to being out of the coronavirus woods. Still, Luckin Coffee (NASDAQ:LK) stock deserves some credit. Yes, it’s lower by 5.43% for the week ending Feb. 27. That’s worse than the aforementioned China indexes, but it’s also better than the S&P 500 over the same period.

LK Stock: Luckin Coffee Faces Tests as Chinese Economy Could Weaken

Source: Keitma /

Additionally, LK stock is a growth name at a time when the virus has rapidly forced growth stocks out of favor. And there’s no sugarcoating the fact that the stock is off 24.46% from its 52-week high, putting it in a bear market.

Over the near-term, Luckin could be something of a dichotomy. There’s no question that China as a coffee market is a massive opportunity. Chinese consumers warming up to java is a recent phenomenon. It’s not yet etched in their fabric as it is in the U.S. and that provides a compelling platform for growth for Luckin and others.

However, it also can’t be ignored that the economy there is on fragile ground due to the COVID-19 outbreak.

Near-Term Challenges for LK Stock

In a letter to staffers on Thursday, Starbucks (NASDAQ:SBUX) CEO Kevin Johnson said that company — a primary Luckin rival — has reopened at least 85% of its stores in China. That can be seen as good news for both companies, but Johnson acknowledged COVID-19 has “disrupted people’s lives throughout China.”

Reopening stores of any kind in China right now is good for optics, but with the country still under harsh travel restrictions, the question is who’s actually going outside for any significant amount of time?

“Many malls and stores remain shut and sales of cars and smartphones are crumbling, but demand for health, entertainment and cosmetics products is buoyant, according to data from e-commerce giant Alibaba,” reports Reuters.

What are the hot items in China right now? Inside fare such as yoga mats, books, video games and, yes, condoms. That’s not good news for experiential companies like a Luckin or a Starbucks.

Getting back to the pesky issue of the Chinese economy, at 9 a.m. Beijing time on Saturday, the February reading of the Purchasing Managers’ Index (PMI) is due out and economists are forecasting a reading of 45. Numbers below 50 indicate contraction and if the report comes in at 45, it would be China’s worst since the dark days of the global financial crisis in 2008.

A reading below 45 and Chinese consumer discretionary names, including LK stock, will likely suffer. Should China produce GDP growth too far below 6% this year, that could lead to even harsher treatment of consumer stocks, particularly richly valued growth fare such as Luckin.

Bottom Line

There’s no need to be a hero with Luckin right now. Coffee itself can be irresistible, but investors should resist the urge to step into a consumer name dependent on the mobility of those consumer in what is now a fragile, virus stricken economy.

Yes, Luckin’s growth story is compelling, but no one knows when the coronavirus issue is going to abate. Moreover, the prospects of a V-shaped recovery, as was experienced following the SARS epidemic, appear murky, as does the outlook for China attaining the important 6% GDP growth level global investors were anticipating at the start of this year.

As of this writing, Todd Shriber did not own any of the aforementioned securities. He has been an InvestorPlace contributor since 2014.

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