China loves Starbucks (Exchange: New York; ticker: SBUX).
After entering China in January 1999, there are now over 3,700 Starbucks outlets in China – making China the company’s second-largest market next to the U.S.
Starbucks sees so much potential for the Chinese coffee market that it’s aiming to have 6,000 stores in China by 2021.
But Starbucks isn’t the only coffee shop in town…
Homegrown competitor Luckin Coffee has about 2,000 outlets in China. And it’s catching up fast – opening 2,500 new outlets this year alone, which is nearly three times the rate of Starbucks’ ongoing expansion. This puts Luckin Coffee on track to have more outlets in China than Starbucks does by the end of the year.
This fast-growing company now plans to raise up to US$800 million from investors by listing its shares on the New York Stock Exchange.
So should you buy into its IPO?
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Three questions to ask before you buy
IPOs are exciting – they offer the promise of owning shares in a company with great plans for the future. And they allow ordinary investors to finally invest in companies that previously were unavailable to them.
But there are three important things to ask before putting money into any IPO:
1. Is the company profitable?
Despite having 2,000 outlets last year and selling over 90 million items (mostly cups of coffee), Luckin Coffee isn’t profitable.
Luckin Coffee disclosed that it lost US$241 million in 2018 on revenue of US$125 million. It lost nearly twice as much as it made in revenue.
A fast-growing company that’s losing money isn’t unusual. There are many loss-making companies that have become successful investments, including Netflix (Exchange: New York; ticker: NFLX) and Tesla (Exchange: New York; ticker: TSLA).
But it’s important for a loss-making company to have a strategy to eventually become profitable.
In its prospectus, Luckin Coffee states that “There is substantial uncertainty with respect to our results of operations and we cannot assure you when we will achieve profitability.”
That doesn’t sound encouraging.
2. Does the company have an operating record?
Luckin Coffee was founded in Beijing in October 2017. That means the company has only been in existence for a little over 18 months.
By contract, Starbucks was operating for 21 years before it listed its shares.
Having a track record is important, especially for a bricks-and-mortars business like selling cups of coffee over a counter. A long track record means a company has established that its business model works, and that it’s something it can replicate.
So how was Luckin Coffee able to open up 2,000 outlets so quickly?
Most of its outlets are what are called pick-up stations. These are kiosk-type shops that have little to no seating, are manned by just a couple of employees and are geared towards the takeout and delivery market.
With most of the company’s outlets open for less than a full year, Luckin Coffee doesn’t have the operating track record that would show its business is sustainable beyond the current pace of growth.
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3. Does the company have a unique advantage?
Starbucks changed the way people experienced coffee in a retail setting. This has allowed Starbucks to expand into over 100 different countries and dominate almost wherever they went.
Does Luckin Coffee have its own unique advantage? The answer right now is no.
Luckin Coffee sells coffee at prices about 20 percent lower than Starbucks and focuses on takeout and delivery. Neither of these are unique. They are also easily replicated by companies looking to compete against Luckin Coffee in the future.
These are just three important questions you need to ask before buying Luckin Coffee’s IPO (and any future IPO).
And it pays to wait for companies to go through one or two earnings reports after its IPO. That way, you’ll have a better picture of what’s under the hood of the business.