Luckin Coffee’s “Mist”: Share price surges 70%; Starbucks makes 5 yuan while losing 6 yuan on a cup of American coffee

The cumulative loss is 3.4 billion yuan.

Recently, Luckin Coffee (Nasdaq: LK) released its third quarter financial report for 2019. During the reporting period, the company achieved revenue of 1.542 billion yuan, a year-on-year increase of 540.2%; according to non-GAAP, the net profit loss was 491 million yuan, more than 30% of the revenue; the net loss in the same period of 2018 was 484 million yuan, twice the revenue of the current period.

With revenue increasing fivefold and losses decreasing, Luckin Coffee's Q3 financial report exceeded Wall Street expectations. The company's stock price also soared, from a closing price of less than $19 on November 12 to a 60% increase to over $30, closing at $32.10 on November 26, up 69.13% from before the financial report was released.

Time Finance contacted Luckin Coffee’s public relations department, who said that the financial report was the final word and that they would not accept interviews for now.

Lose 500 million and beat the one who earns 5.6 billion?

Less than half a year after it started operating in 2018, the media was still comparing Luckin Coffee with coffee delivery brands such as Lian Coffee. In an interview at the time, Luckin Coffee CEO Qian Zhiya said that the team’s goal was to become Starbucks. It seems that this goal is about to be achieved.

According to the financial report, as of September 30, 2019, Luckin had 3,680 directly-operated stores, an increase of 717 stores from the end of the previous quarter. Although there is still a big gap compared to Starbucks' 31,000 stores worldwide during the same period, it is only 445 stores away from Starbucks' 4,125 stores in mainland China at the end of the third quarter.

Data source: Luckin Coffee & Starbucks financial reports

Luckin Coffee's management said in a conference call that the company expects to add more than 800 directly-operated stores in the fourth quarter, while Starbucks expects the number of stores in mainland China to grow by 10%-20% (mid-teens growth) in the next four quarters, that is, 410 to 820 stores. Based on this calculation, Luckin Coffee's number of stores in mainland China is likely to surpass Starbucks in the fourth quarter of this year.

Data source: Luckin Coffee & Starbucks financial reports

But surpassing the number of stores does not mean that Luckin Coffee has defeated Starbucks, which has been in China for 20 years. According to the financial report, Starbucks' revenue in the third quarter of 2019 was US$6.747 billion, while Starbucks China's revenue in the third quarter was US$763 million. In terms of revenue alone, Starbucks is 31 times that of Luckin Coffee, and Starbucks China is 3.5 times that of Luckin Coffee.

The difference in profitability is even greater than the revenue gap. In the third quarter of this year, Luckin Coffee lost $69 million, while Starbucks' net profit was $1.161 billion, accounting for 17.2% of its revenue. In other words, for the same cup of American coffee, Starbucks can make $5 at $28, while Luckin Coffee, which sells for $21, loses $6.

The gap between the two is also reflected in market value. As of the close of trading on November 19, Eastern Time, Starbucks' total market value was US$98.802 billion, 15.6 times the market value of Luckin Coffee, whose stock price has soared recently. To be fair, Wall Street has not underestimated Luckin Coffee's value. Even if we consider that Luckin Coffee has not yet made a profit, and do not use the most commonly used secondary valuation tool, the price-to-earnings ratio (market value/profit), to compare, judging from the third quarter's price-to-sales ratio (market value/revenue), Luckin Coffee is still twice that of Starbucks.

Competing for "internal strength"

If store growth, revenue, and stock price are the muscles that Luckin Coffee and Starbucks show off externally, then operational capability is their internal strength. In terms of internal strength, there is obviously a big gap between Luckin Coffee, which believes in "speed is invincibility", and Starbucks, which believes in "steady and steady wins the race".

Source: Luckin Coffee Financial Report

According to the third quarter financial report, compared with last year, Luckin's revenue increased 5.6 times, the number of goods sold increased 4.7 times, and the monthly active users increased 4 times, while the number of stores only increased 2 times. According to Qian Zhiya, the revenue growth is greater than the number of goods sold, the number of users, and the number of stores, which proves that Luckin's growth is not simply due to the increase in the number of stores or users, but due to the improvement of operational capabilities.

It is obviously not objective to only talk about the vertical without talking about the horizontal. Operational capacity itself does not have a comparable value like stock price, but the operation of an enterprise is nothing more than "increasing revenue" and "reducing expenditure", so the difference in details between the two can still be compared from revenue and cost.

Let’s talk about revenue first. The models of Starbucks and Luckin are similar, but also different. Starbucks is a traditional offline retailer, finding the most suitable offline location and opening a store to make money from it; while Luckin first “buys” users on the APP, and then builds a site when it finds that the user needs of a certain place cannot be met.

According to the explanation given by Luckin Coffee’s management in the third quarter earnings conference call: “Traditional retail is to find a store first, then renovate it and wait for business, but we find consumers through food delivery first and then open stores. Our growth is not through the growth of stores, we open stores to meet customer needs.”

Luckin's model determines its "speed", while Starbucks' years of accumulation determine its "stability". It is difficult to say which one is better. However, both of them cannot do without offline stores. The coverage area of ​​a single store in the surrounding area, its ability to attract users, the user repurchase rate, and the bargaining power of the brand all determine the ability of each Luckin and Starbucks store to make money. The average revenue of the store is the best comprehensive reflection of this.

Data source: Luckin Coffee & Starbucks financial reports

As shown in the above figure, compared with the beginning of last year, the average revenue per store of Luckin Coffee has increased significantly this year. Except for the Q1 Spring Festival off-season, the average single store revenue was 200,000 yuan, Q2 reached 326,000, and Q3 reached 450,000. However, it is much worse than Starbucks China, and the peak in Q3 was only 1/3 of the latter. (Note: Luckin's data uses revenue divided by the average number of stores in the quarter, while Starbucks Q3 uses the number of Starbucks China stores at the end of the quarter)

In terms of cost, Qian Zhiya said at the Luckin Global Partner Conference in May this year that one of the advantages of the Luckin model is that the app simplifies the traditional offline store links such as cashier, reducing costs. And from the perspective of stores alone, Luckin's costs are indeed lower than Starbucks.

Source: Luckin Coffee Financial Report

Luckin Coffee stores are mainly divided into three types: quick-service stores, takeaway kitchens, and leisure stores with a similar positioning to Starbucks. According to the financial report, 3,433 out of 3,680 stores are quick-service stores, and there are only 138 leisure stores, accounting for only 3.75%.

According to a person claiming to be a "former Starbucks employee" on Zhihu, the cost of opening a Starbucks store is about 3 million yuan. In comparison, the cost of a quick-service store is much lower than that of a Starbucks store. According to previous media reports, the area of ​​Luckin's quick-service stores is generally only 25-50 square meters, less than half of a standard Starbucks store (100 square meters), the decoration is relatively simple, and the number of operating staff is also smaller.

But this does not seem to explain Luckin's losses. Many people attribute Luckin's losses to subsidies. Luckin's subsidies are divided into two parts: subsidies for giving new users a free drink and subsidies with coupons such as "buy 2 get 1 free". The former is included in Luckin's raw material costs and accounts for about 3.5% of Luckin's revenue based on the number of new users this quarter.

Data source: Luckin Coffee prospectus and financial report

According to the explanation given by Luckin Coffee's management in the conference call, the subsidy from the coupons is reflected in the reduction in the average unit price of each cup of beverage. As shown in the above figure, the change in the subsidy intensity can be reflected from the unit price of a cup of Luckin Coffee's beverages.

Subsidies reduce revenue and increase costs. In addition, a large part of Luckin's costs comes from marketing expenses. As mentioned above, Luckin's model is to attract users to the app through marketing. If Starbucks' "customer acquisition cost" is the expensive decoration of the store and the service of the staff, then Luckin is real money advertising.

Source: Luckin Coffee Financial Report

Since its establishment two years ago, Luckin Coffee's customer acquisition costs have experienced a process of first falling and then rising. As shown in the above figure, Luckin's customer acquisition costs continued to decline in the first five quarters of 2018, from the initial 103.5 yuan to 16.9 yuan in the first quarter of 2019. In the past two quarters, Luckin's customer acquisition costs have increased significantly, with the cost of acquiring each new user being 55.2 yuan, of which 6.5 yuan is the cost of new user gifts and 48.7 yuan is the cost of marketing activities.

Data source: Luckin Coffee’s financial report

Since 2019, Luckin's user growth rate has slowed down significantly, from more than 100% in multiple quarters of 2018 to 35%. Starting from the second quarter of 2019, Luckin significantly increased its marketing expenses, and the user growth rate remained at 35% in the next two quarters. As a result, the cost of acquiring customers also soared to 55 yuan.

Luckin's customer acquisition costs hit a new high since the second quarter of 2018, and Luckin's marketing expenses in the third quarter reached 558 million yuan, up 148% year-on-year and 43% month-on-month. This does not include the "cost of free coffee for new users" calculated in the raw material costs. Luckin added 7.9 million new users this quarter, and the cost of a single cup of coffee freebie is 6.5 yuan, which means that Luckin will have to pay an additional 51.35 million yuan.

Luckin's marketing expenses account for 36% of receivables, and when the cost of coffee giveaways is included, it reaches 39.5%. In comparison, Starbucks is famous for not advertising. Although Starbucks has also begun to try digital marketing in the era of social media, it is basically limited to operating social media accounts on social media and its own apps. It does not even list market and marketing expenses separately in its financial reports.

Qian Zhiya said in a conference call: "Brand building is very important for our long-term development. From Q2 2019 to Q2 2020, Luckin invested heavily in brand building. During this period, marketing expenses were high, and this part will return to normal starting from Q3 2020. In addition, marketing expenses this quarter were higher than expected, mainly due to the launch of Xiaolu Tea stores and partnership operation models. Next quarter's marketing expenses will be lower than this quarter."

After the promotion period, it is not difficult to reduce marketing expenses to a reasonable level. However, for Luckin, which relies on mobile clients as a channel for acquiring new users, it is almost impossible not to do marketing like Starbucks. It costs less to open stores, but more to advertise. How much lower can Luckin's costs really be than Starbucks? We may be able to get a glimpse of this when Luckin returns to "normal" next year.

How long can it "burn"?

In addition, there are two issues about Luckin Coffee that are particularly worthy of attention.

The first question is, how long can Luckin Coffee keep burning money? Excluding the personal investment of Qian Zhiya and Lu Zhengyao in the early stage, Luckin Coffee has completed four rounds of financing so far, including $550 million in pre-IPO financing, and $657 million from the IPO in the United States and private placements during the same period, totaling about $1.2 billion. According to the financial report, Luckin Coffee has accumulated a loss of $489 million (about 3.439 billion yuan) as of the third quarter of this year.

Source: Luckin Coffee Financial Report

Of course, losses cannot be equated with the consumption of cash flow, especially for a retail enterprise like Luckin Coffee, where fixed asset investment for opening stores is a big part of the cost. However, according to Luckin Coffee’s financial report, Luckin Coffee, which just completed its IPO, does not need to worry too much about running out of funds.

According to the financial report, Luckin had 4.5 billion in cash and cash equivalents at the end of the third quarter. This quarter, Luckin's cash flow from reduced operating activities was 120 million. Even if the funds consumed by opening stores are added, Luckin will not have too high liquidity risk in the short term.

Source: Luckin Coffee Financial Report

The second issue is Xiaolu Tea and franchise stores. In recent quarters, the proportion of non-coffee in Luckin's revenue structure has been increasing, from 30.9% in 2018 to 44.9% in the third quarter, and Xiaolu Tea is undoubtedly the main force.

In August this year, Luckin launched the "Xiao Lu Tea Partner" plan. According to Qian Zhiya's introduction in the conference call, Xiao Lu Tea stores will be different from Luckin Coffee stores in three aspects: first, the proportion of tea drinks in the SKUs of Xiao Lu Tea stores is higher, and coffee is less; second, in terms of coverage area, Luckin Coffee is mainly in first- and second-tier cities, while Xiao Lu Tea will focus on low-tier cities to develop the sinking market; third, Xiao Lu Tea will introduce franchises, while Luckin Coffee will continue to insist on direct operation.

According to the management in the earnings conference, about 2,000 franchise requests have been received, and according to several Xiaolu Tea stores that have already started the pilot, Luckin's direct-operated stores are doing well, basically at the same level as Luckin Coffee stores; franchise stores are both good and bad.

For Luckin Coffee, which is finding it increasingly difficult to expand in first- and second-tier cities, sinking into the lower-tier markets and the franchise model are undoubtedly the most effective means to break through the bottleneck of growth. However, both tea drinks and the sinking market are quite different from the coffee business that Luckin Coffee has been doing for two years. Can Luckin Coffee's approach of attracting customers online and opening stores offline break through the siege of "Heytea"? Will the sinking market buy in? More time is needed to verify. (Beijing Time Finance Ouyang Feng)