Once a promising growth firm capitalizing on the burgeoning coffee-consumption trend in China, Luckin Coffee (OTCMKTS:LKNCY) instead became emblematic of the vices surrounding the world’s second-largest economy. Namely, the corruption and lack of transparency that has stymied U.S.-China relations in the past came to remind us all that there’s still much work to be done. And because of the still-toxic nature of Luckin stock, investors should avoid it.
Of course, that doesn’t seem like a smart move at the moment. A few weeks ago, the Securities and Exchange Commission (SEC) essentially handed Luckin stock a reprieve. On paper, it doesn’t look like it. According to a CNBC report, Luckin Coffee agreed to pay a $180 million penalty to settle the accounting fraud charges, when in 2019, the company overstated its revenue and understated its net loss.
However, while the SEC found that Luckin “intentionally and materially” misled investors with its manipulated financials, the Chinese coffee brand did not admit nor deny the allegations. Furthermore, “The company has agreed to pay the penalty, which may be offset by certain payments it makes to its security holders in connection with its provisional liquidation proceeding in the Cayman Islands.”
Put another way, Luckin got lucky, all things considered. Yes, it has to pay the $180 million penalty, which is not chump change. However, the disgraced company gets to put the ordeal behind it. As well, TechCrunch.com reported that Luckin claims its operations are “stable and normal.” That’s usually not the outcome for a fraud of this nature.
More critically, other people had the same interpretation. From trading under $4, Luckin stock climbed to $9.42 before settling down at a much-higher threshold compared to prior months.
Is there a chance that LKNCY stock could be 2021’s redemption narrative? I wouldn’t count on it.
Yes, Cheating Is Still a Big Deal for Luckin Stock!
Certainly, Luckin stock is a beneficiary of FOMO, or the fear of missing out. Prior to the disclosure of the accounting fraud, many proponents jumped on the LKNCY bandwagon — well, before it was known as LKNCY, to be clear — due to its massive potential.
As data from the USDA Foreign Agricultural Service indicates, total coffee consumption in China has grown steadily since the 2014/2015 crop year. As well, the middle class is growing as the country continues to reap the benefits of its economic “miracle.” Nominally, you have a huge base that is working and playing in major metropolitan areas. And that benefits Luckin stock fundamentally, as the underlying company’s stores and kiosks are conveniently located in high-traffic zones.
However, that’s not enough to overcome the stench that emits from the coffee retailer. Over the years, we’ve seen a number of high-profile (and deeply embarrassing) accounting scandals. Only a select few have recovered, and within this field, a tiny minority have outperformed expectations.
I mention this because it’s not out of the realm of possibility that Luckin stock shoots higher. But is it probable? That’s an entirely different question, and one where the facts don’t provide much confidence.
In one of my prior articles about Luckin, I cited research from the Northwestern University Kellogg School of Management, which stated that trust is an integral component of the investment market. Specifically, “Most of us will not enter a three-card game played on the street, even after observing a lot of rounds (and thus getting an estimate of the “true” distribution of payoffs). The reason is that we do not trust the fairness of the game (and the person playing it).”
That’s a perfect description of Luckin stock: three-card Monte.
Why It Matters
While there’s an argument to be made that everyone will eventually move forward, this concept should not be applied too liberally for Luckin stock. That’s because if we’re being intellectually honest, most people will have the fraud issue in their minds when they speculate on the stock.
But that’s exactly what you don’t want in a long-term investment: investors thinking about whether their target asset is truly on the up and up. Therefore, once they’ve made a healthy profit, any hint of volatility could scare off stakeholders who ordinarily might not care if fraud wasn’t an issue.
Yes, Luckin is no longer in penny stock territory under the classic definition. But it might trade like one because you just don’t know about the company anymore. And while you might be the forgiving type, others might believe that once a cheater, always a cheater. Personally, that’s too big of a risk to take.
On the date of publication, Matthew McCall did not have (either directly or indirectly) any positions in the securities mentioned in this article.
On the date of publication, neither Matt McCall nor the InvestorPlace Research Staff member primarily responsible for this article held (either directly or indirectly) any positions in the securities mentioned in this article.