Smartkarma Research How Luckin Coffee Spilt The Beans

How Luckin Coffee Spilt the Beans
Independent Research Has a Bitter Brew for China’s

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Cover image by Stellasun666, shared under CC BY-SA 4.0 2
Table of Contents
1. Luckin Coffee (瑞幸咖啡) App Walk-Through and Channel Checks .................................................................. 4
2. Luckin Coffee IPO: Wake up and Smell the Coffee ........................................................................................... 17
3. Luckin Coffee (瑞幸咖啡) Vs. Starbucks (星巴克) - Still Has a Long Way to Go .............................................26
4. Spilling the Coffee: Rapid Expansion Without Much Due Diligence Could End in Disaster............................31
5. Luckin Coffee (瑞幸咖啡) - Base Case Valuation - Cheap Coffee Expensive Company .................................46
6. Luckin Coffee (瑞幸咖啡) - Blue-Sky/Bear-Case Valuation............................................................................... 54
7. Luckin Coffee (瑞幸咖啡) IPO Review - Marketed Valuation Is Closer to Our Blue-Sky Scenario ..................60
8. Luckin Coffee IPO: Best Latte Scenario Priced In Unless You See Data Coffee .............................................66
9. Luckin Coffee (瑞幸咖啡) - The Art of Burning Cash for Market Share ...........................................................73
10. Luckin Coffee: Top Line Growth May Not Be Enough to Generate Positive Operating Margins ....................79
11. Luckin Coffee (瑞幸咖啡) IPO Trading Strategies ............................................................................................. 91
12. Luckin Coffee's Upsized IPO: Why Investors Trod Where Analysts Feared? ...................................................96
13. Luckin Coffee: A Quick Path to Profitability Possible but Unrealistic – Quantamental................................101
14. Luckin Coffee (瑞幸咖啡) Lock-Up Expiry - Short Closer to Q3 as Pre-IPO Investors May Look to Sell ......108
15. Luckin Coffee 3Q19 Quantamental Analysis: Price Hike Unjustified as Marginal Cost Improvements
Fade ...................................................................................................................................................................115
16. Luckin Coffee’s Unit Cost Dynamics ................................................................................................................121
17. Luckin Coffee: Recent Spike in Arabica Coffee Prices to Affect Margin Improvement................................129
3
Luckin Coffee (瑞幸咖啡) App Walk-Through and Channel Checks
Luckin Coffee | Equity Capital Markets
Luckin Coffee (瑞幸咖

啡) App Walk-Through
and Channel Checks
Zhen Zhou, Toh
By Zhen Zhou, Toh | 24 Apr 2019
APAC IPOs & Placements

E X E C U T I V E S U M M A RY
Luckin Coffee (LK US) is looking to raise up to US$800m in its upcoming IPO.
We written our early thoughts in Luckin Coffee (瑞幸咖啡) Early Thoughts -
Caffeine Rush
In this insight, we will do an app walk-through and share our thoughts from
channel checks about Luckin Coffee.
D E TA I L
Trying the app
Opening the app, the user is greeted with simplistic and aesthetically
pleasing drawings with brief introduction that Luckin Coffee uses top quality
arabica beans and has coffee recipes designed by World Barista Champion
teams.
Zhen Zhou, Toh 4

Zhen Zhou, Toh 5

You can also choose the city you are in and find the shops that are available
or near you for pick-up or delivery.
Zhen Zhou, Toh 6

Zhen Zhou, Toh 7

After choosing the shop, or just switching on location sharing, you are
allowed to access the shop's menu. To be honest, we were surprised by the
number of non-coffee beverages and food items that were offered. But, as
shown, coffee is priced rather cheap while discounts were given on food
products.
Zhen Zhou, Toh 8

You can also send a friend, who has not purchased a Luckin Coffee before, a
free coffee invitation and also get to enjoy one free cup yourself (very similar
to how Uber and Grab started). You can also give coffee red packet (first
photo second option).
Zhen Zhou, Toh 9

Zhen Zhou, Toh 10

There are also discount coupons you can purchase in advance shown in the
second screenshot. Other than that we do not see any more discounts given
other than special events that gave 1 for 1 drinks and cash discounts.
Zhen Zhou, Toh 11

Zhen Zhou, Toh 12

Zhen Zhou, Toh 13

Thoughts
After exploring the app for about half an hour, it is clear that there
isn't anything proprietary about the app. Needless to say, it is well-
built and easy to use like most Chinese apps, but the concept of
ordering on the app and collecting after to improve operating
efficiency is not a new concept. We have seen that being done in
supermarkets in China and even small restaurants in shopping malls
have that capability.
Channel checks - most were

unimpressed, buying because its
cheap
On an anecdotal level, I traveled around China for half a month in April last
year and there had already been advertisements of Luckin Coffee in
Shanghai. Unfortunately, I had not been able to have taste of the coffee
myself but the advertisements were clearly positioning Luckin as a top
quality coffee retailer, boasting about their partnership with world
champions and their top quality beans. Looking at the company's growth, it
is understandable that the company had such explosive growth. There had
probably been a lot of customers curious about the brand and went to try it.
Fast forward to today, based on our channel checks, most people were
unimpressed and said that Luckin is basically competing on price. The
consensus seems to be that Luckin's beans are better and its cheaper than
Starbucks but they would not buy without discount even though the full
retail price is ultimately still cheaper than Starbucks.
Zhen Zhou, Toh 14

Zhen Zhou, Toh 15

Our channel checks seem to be consistent with the interviews done by

TechNode wherein Luckin is generally seen as different from Starbucks and
that the first reaction from people is that they are just either curious or, for
those who have tried, unimpressed.
There were also many of these Luckin vs Starbucks comparison videos

uploaded on Bilibili Inc (BILI US). The consensus from these comparisons
tend to be split.
These reviewers thought that Starbucks is still ahead in terms of their coffee
but their non-coffee drinks seemed poor compared to Luckin Coffee.
Our thoughts
Our channel checks left us skeptical about Luckin Coffee's brand.
From the consumer perspective, Luckin is often seen as the brand
that has cheaper and more convenient coffee than Starbucks whereas
the taste test has had mixed reviews. Some like Luckin over
Starbucks and vice versa while most seemed indifferent.
In our view, the two have different value proposition. Starbucks offer
the full coffee experience in which one buys coffee and sit around to
enjoy it whereas Luckin focuses on convenience and offering cheaper
coffee. We think that Luckin still has a long way to go in building a
sustainable brand.
We have labelled the insight bearish because we do not see Luckin
having a clear advantage over Starbucks. In the next insight, we will
look at competition in China and how Luckin stacks up against its
competitors.
Disclosure & Certification

• I/We have no position(s) in the any of securities referenced in this insight
• Views expressed in this insight accurately reflects my/our personal opinion(s) about the referenced securities and issuers and/or
other subject matter as appropriate.
• This insight does not contain and is not based on any non-public, material information.
• To the best of my/our knowledge, the views expressed in this insight comply with Singapore law as well as applicable law in the
country from which it is posted
• I/We have not been commissioned to write this insight or hold any specific opinion on the securities referenced therein
• I/We have signed the Insight Provider Agreement and this insight does not violate any of the terms specified therein.
— Zhen Zhou, Toh (23 Apr 2019)
Zhen Zhou, Toh 16

Luckin Coffee IPO: Wake up and Smell the Coffee
Luckin Coffee IPO:

Wake up and Smell the
Coffee
Rickin Thakrar
By Rickin Thakrar | 25 Apr 2019
IPO and L/S equity, 2015

Starmine top stock picker E X E C U T I V E S U M M A RY
Luckin Coffee (LK US), a high growth coffee chain in China, has filed for an
IPO to raise 800mn USD (Source: Reuters). We note the following points.
Intro to Luckin IPO
Slowing exit rate and high cash burn amidst financials in our view
A great growth market beset by tough competition
D E TA I L
Intro to Luckin IPO

Luckin, which opened in June 2017, is now the second largest coffee chain in
China based on store count and cups of coffee sold, according to its prospectus.
Luckin is seeking to raise up to 800mn USD and files its IPO one week after
receiving series B financing of 150mn (Source: Drum news).
Below are some key stats for the Luckin coffee IPO, as shown in figure 1.
Figure 1: Key stats for Luckin Coffee IPO
Ticker LK US
Amount to be raised $800mn USD
Total revenue 841mn RMB as of FY18
Revenue growth c336,000% yoy growth in FY18, 3594% growth in 1Q19
EBIT margin -190% margin in FY18, -110% margin in 1Q19
FCF (RMB) -2.6bn RMB in FY18, -828mn in 1Q19
Stores 2370 owned
Net debt 2.9bn net debt as of FY19 including mezzanine equity, 3.7bn as of Mar. 19
Competitors Starbucks, Mcdonalds, Tim Hortons, Costa Coffee (Coca-Cola), KFC and FamilyMart
Lead bookrunners CS, Morgan Stanley, CICC, Haitong
Source: GER research
Rickin Thakrar 17
We note a few points from figure 1 above:
• Luckin has generated phenomenal growth despite only being around

for 18 months and increased from one store in mid-2017 to over 2300 as
it currently stands.
• We note that the cash burn for Luckin is high – and we estimate around
400mn USD in cash burn in FY18.
• Luckin has a slew of international competition with Starbucks, Tim

Hortons, Costa, and KFC aggressively expanding coffee outlets and
ranges
Slowing exit rate and high cash burn

amidst financials in our view
Below are the available financials for Luckin coffee, as reflected in its income
statement (Figure 2).
Figure 2: Luckin Income statement
Source: Global Equity Research
We note a few points from Luckin’s income statement above:
• Luckin has been in operation since June 2017 so there are only about 18
months of financials available
Rickin Thakrar 18
• Luckin’s gross margin is fairly low at 37% compared to 60% for

Starbucks globally for its operations
Perhaps the biggest concern for Luckin is that there might be some
indication of a slowdown when looking at Luckin’s exit rate, as reflected in
the figure below (Figure 3).
Figure 3: Some signs of a slowdown in QoQ revenue growth?
We note a few points from figure three above
• It looks as though Luckin’s revenue growth QoQ slowed to 3% in 1Q19

compared to 93%. Luckin attributes this to seasonality in its trade and a
slowdown during the Chinese new year (as shown in figure 4).
Figure 4: Luckin notes seasonal slowdown which may have impacted the
latest quarterly exit rate
From figure 4 above, it is difficult to verify as Luckin has only been in

operation for one full calendar year. Moreover, we find that Luckin has
slowed its QoQ expansion, perhaps reflective of its cash burn and need for
external financing, as shown in figure 5.
Rickin Thakrar 19
Figure 5: Luckin may have slowed expansion QoQ, reflective of potential

cash requirements
Stores 4Q17 1Q18 2Q18 3Q18 4Q18 1Q19
Total stores 9 290 624 1189 2073 2370
Pick-up stores 4 83 356 903 1811 2163
Relax stores 5 15 22 45 86 109
Delivery kitchens 0 192 246 241 176 98
QoQ growth in store openings 4Q17 1Q18 2Q18 3Q18 4Q18 1Q19
Total stores 3122% 115% 91% 74% 14%
Pick-up stores 1975% 329% 154% 101% 19%
Relax stores 200% 47% 105% 91% 27%
Delivery kitchens 28% -2% -27% -44%
Source: GER research, company filings
Big picture, it may be true that Luckin’s recent quarter slowdown is due to
seasonality, however, the company only has a few quarters of growth to
reference which makes it hard to decipher the underlying reason for any
potential slowdown, particularly in the context of slower store openings.
We note that Luckin is also experiencing significant cash burn, and we are
not sure an IPO will be sufficient at this stage to support its financing needs,
as reflected in its cash flow in figure 6.
Figure 6: Luckin cash flow
Source: GER research, company accounts
From figure 6 above we note that Luckin’s cash burn is significant with 2.6bn
RMB in cash burn in its first full year of operation.
As a result, Luckin’s balance sheet looks stretched, as reflected in figure 7
Rickin Thakrar 20
Figure 7: Luckin balance sheet
Source: GER research, company accounts
We note a few points from Luckin’s balance sheet
• We note that Luckin’s balance sheet net debt (excluding capitalized

leases) increased from 2.9bn RMB to 3.7bn RMB (including mezzanine
equity) from the end of FY18 to March '19.
• We believe Luckin's ambitious growth plans and its cash burn for us
suggests that it may need to come back to the market for further
fundraising.
A great growth market beset by tough

competition
There are positives to the Luckin investment case from a top-down
perspective, which is reflected in the charts below (Figure 8-10)
Rickin Thakrar 21
Figure 8: Per capita coffee consumption remains low relative to other

countries
Source: IPO prospectus

Figure 9: Growth prospects are strong for brewed coffee
Source: IPO prospectus

Figure 10: Coffee prices are at multi-year lows
Source: Factset, WSJ
Rickin Thakrar 22
While at the same time competition to emerge in China in the coffee market
seems fierce with Starbucks, Coca-cola, and Tim Hortons planning to expand
in the country (Figure 11)
Figure 11: Luckin faces competition in China
Stores openings 2017 2018 Plans Notes
Luckin 9 2073 4500 By end of 2019
Starbucks 3124 3684 6000 By end of 2022
Tim Hortons 0 1 1500 Over next 10 years
Costa Coffee 252 440 1200 By 2022
GER view: On first glance, we admire Luckin for its breakneck

growth strategy in China. In a market that is growing and fierce with
the competition, we believe Luckin is probably taking the best step
forward to ensure survival by trying to get the biggest and fastest.
However, there are definite areas of concern 1) There might be
evidence of growth slowdown reflected in Luckin's QoQ figures, 2)
Luckin burned through 2.6bn RMB in cash in FY18 and has a levered
balance sheet - we believe there may be a requirement for further
financing over the medium term whilst investors can only assess one
full year of financials and 3) Luckin faces competition from
Starbucks, Costa, Tim Hortons, and KFC who all have ambitious
growth plans and as such, competition may remain fierce for the
foreseeable future. This is despite the bright prospects for the coffee
space in China. We await the pricing of the IPO .
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Rickin Thakrar 24

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— Rickin Thakrar (25 Apr 2019)
Rickin Thakrar 25
Luckin Coffee (瑞幸咖啡) Vs. Starbucks (星巴克) - Still Has a Long Way to Go

啡) Vs. Starbucks (星巴
克) - Still Has a Long
Zhen Zhou, Toh
Way to Go
By Zhen Zhou, Toh | 29 Apr 2019
You can find our early thoughts in:
• Luckin Coffee (瑞幸咖啡) Early Thoughts - Caffeine Rush
• Luckin Coffee (瑞幸咖啡) App Walk-Through and Channel Checks
In this insight, we will take a closer look at the competitive landscape in

China, specifically Luckin Coffee stacks up against Starbucks.
D E TA I L
Comparison to Starbucks
As per the data by respective companies, the number of stores of Luckin

Coffee is closing in on Starbucks. Luckin has 2,370 stores as of March 31st,
2019 whereas Starbucks has 3,780 company operated stores in China.
Zhen Zhou, Toh 26

However, as per our operating metrics comparison table below, Luckin pales
in comparison on many different metrics.
Category Luckin Coffee Starbucks China Starbucks/

Luckin (%)
No. of stores 2,370 3,789 60%
Planned expansion for 2019 2,500 600 -76%
No. of stores by end of 2019 4,870 4,389 -10%
Quarterly revenue (RMBm) 479 4,730 888%
Average quarterly rev per store (RMB) 201,903 1,248,309 518%
Operating margin (RMBm, LTM, Mar 2019) * -153% 19% N.M.
Average daily no. of customers served per store**** 61.9 300-500 -
Beverage retail sales mix (%)** 76% 74% -2%
Food retail sales mix (%)** 18% 20% 14%
Cost of Americano (RMB)*** 21 27 29%
Cost of Latte (RMB)*** 24 31 29%
Comparable stores sales growth (%) - 3% N.M.
Comparable stores change in transactions (%) - -1% N.M.
Delivery partner SF Express Ele.me N.M.
*Operating margin is based on Starbucks reported Operating Income from

China + APAC region**Retail sales mix data of Starbucks is based on
company level data as of Sep 2018, Luckin is as of Mar 2019***Price of
Starbucks China is from Taobao vs Luckin from its app at full retail
price****Starbucks figure is based on various sources in 2018 and on a
company level basis
Here are some of the key takeaways from the comparison.
• Luckin will over take Starbucks China in terms of the number of stores
by the end of FY2019 (assuming that both companies achieve their
planned expansion).
• However, in terms of quarterly revenue and average quarterly revenue

per store, Starbucks is still earning abut 6x more than Luckin on a per
store level.
Zhen Zhou, Toh 27

◦ We think that the average store size of Luckin's store should be

much smaller than an average Starbucks store and, hence, a
mature Luckin's store could end up serving fewer customers and
operate with lower revenue per store compared to Starbucks.
• The company is operating at -153% operating margin compared to

Starbuck's 19% operating margin (for its APAC + China).
• Luckin only serves about 61.9 customers per day per store (based on
March 2019 data) compared Starbuck's estimated 300 - 500 customers a
day based on various sources we can find.
• In terms of retail sales mix, both companies have a similar split

indicating that both are focused on beverages as their core product.
◦ On that note, interestingly, in Starbucks' recent Q2 earnings call,

there was specifically mentioned the merits of operating a
beverages-first concept store.
“ ◦ And when you look at the shape of our US business what you
see is a very high level of profitability, led by the fact that we are
a beverage first concept, which has very high gross margin.
And we have very strong investment returns in our new units
again led by the fact that we're a beverage first concept that
doesn't have a kitchen they can tend to weigh on total
investment and so our sales to investment ratio is very strong
in the US.
◦ We think that the same merits apply to Starbucks in China and,

consequently, to Luckin as well.
• On a per cup of coffee basis, it is clear that Luckin is trying to undercut

competition by selling coffee at a much cheaper price. Before discount,
Starbucks' classic coffees such as Americano and Latte are consistently
29% more expensive than Luckin.
• Starbucks had also rolled out of delivery services in China partnered

with Alibaba's Ele.me. There isn't much comparisons that we can do
except that Starbucks revealed that their average delivery time was 20
minutes while Luckin does not provide any details on that.
◦ It seems like Starbucks have been aggressive in rolling out delivery

services.
Zhen Zhou, Toh 28

“ ◦ We are building on that brand strength and have successfully

rolled out Starbucks Delivers in partnership with ALIBABA to
more than 2,100 stores across 35 cities throughout China. Our
team in China accomplished this in only 4 months again
demonstrating our operational agility. While still in the launch
phase performance to date is meeting our expectations with
average delivery time under 20 minutes, higher average ticket
and strong trial from existing Starbucks Rewards members.
This gives us confidence that we are building a meaningful and
sustainable delivery channel to complement our existing in-
store experience, as we plan to expand Starbucks Delivers to
3,000 stores across 50 cities in China by the end of fiscal 2019.
◦ We note that this is in contrast to what Luckin is doing in its

operations. Delivery orders as percentage of total orders fell to
27.7% in March 2019 from 61.7% in 1Q 2018 as the company
increased the number of pick-up stores while delivery kitchens
have been on a decline.
Our thoughts - Luckin is the one in

the hot seat
In our previous insight, we argued that the two companies have
different value proposition; Starbucks offer the full coffee experience
while Luckin is about convenience.
But, with the introduction of delivery, Starbucks technically offers
everything Luckin has to offer which basically leaves Luckin to
compete on price. Hence, we think that Luckin is the one in the hot
seat as it needs to figure out how to strengthen its brand amidst its
aggressive expansion and that leaves little room for error.
Other competitors - Cafe Benne and

Costa Coffee
Caffe Bene's failed aggressive

expansion
Luckin's was not the first to have tried to expand aggressively in China.
There had also been a recent example of failure due to aggressive store
expansion seen through CaffeBene, a South Korea coffee chain. CaffeBene
came to China in 2012 through the set-up of a joint venture named Caffe
Bene Management.
Zhen Zhou, Toh 29

The company expanded its presence rapidly in the China's first, second, and
third-tier cities mainly through franchising. At one point, the company had
over 600 stores in China and once opened 200 outlets in a single year.
Based on our research, the failure seemed to be a mix of poor execution of

expansion plans and failure to understand consumer demand in China which
eventually led to the company filing for bankruptcy.
Costa Coffee
Other than Starbucks, Luckin also competes with other international and
local brands. As per media reports in 2018, Costa Coffee which recently got
bought by Coca Cola Enterprises (CCE US) is aiming to have 1,200 stores in
China by 2022.
We have labelled the insight bearish because our comparison shows that
Luckin is still very far from becoming the market leader in terms of
revenue. We will follow-up with early thoughts of valuation in our next
insight.

Zhen Zhou, Toh 30

Spilling the Coffee: Rapid Expansion Without Much Due Diligence Could End in Disaster
Spilling the Coffee:

Rapid Expansion
Without Much Due
Oshadhi Kumarasiri
Diligence Could End in
Equity Analyst
Disaster
By Oshadhi Kumarasiri | 02 May 2019
Luckin Coffee (LK US) is a Chinese start-up going head to head with
Starbucks Corp (SBUX US) in Luckin’s own backyard, China. Starbucks has
dominated the Chinese coffee scene for years now and they have been
growing steadily in China for the last couple of decades. However, this up
and coming Chinese coffee start-up has plans to surpass Starbucks in China
st
by FY2019, within just 2 years of opening their 1 coffee shop.
As this rapid expansion requires capital, Luckin Coffee Inc. has filed for an
IPO on NASDAQ to raise about $800m. Further details such as the valuation
range, offer price range and number of shares to be issued are yet to be
disclosed.
Content
• Chinese Coffee Industry Overview
◦ Coffee vs tea
◦ Chinese coffee Industry growth
◦ China compared to other major coffee consumers
• China is not Ready for Luckin’s Strategy
◦ Luckin’s strategy: Success is unlikely
• Would the Market Get Overcrowded?
• Luckin May Run Out of Luck
◦ Finding it difficult to reduce its dependence on discounts and

coupons to attract customers
◦ Competitors have more resources in case they decide to compete

on price
• Results: Recent Trends
Oshadhi Kumarasiri 31
• Luckin’s Strategy: Profits Difficult to Come By
• How Many of the Restaurants are Making Money?
• IPO: Shareholders Would Demand Positive Results from Mature Stores
• Valuation: Stick with Starbucks for both your Coffee and Money
D E TA I L
Chinese Coffee Industry Overview
• Tea Vs Coffee
Chinese people have always liked their tea more than they liked coffee.
However, the love for coffee is starting to gain ground among Chinese people
as the growth of coffee consumption is outpacing the growth of consumption
of tea by a significant margin. According to a Frost & Sullivan Report, from
FY2013-18 the overall Chinese coffee market grew at a CAGR of around 30%
while the tea market remained stagnant.
Tea vs Coffee Consumption
Source: Statista
• Chinese Coffee Industry Growth is Experiencing Rapid Growth
The same Frost & Sullivan Report also forecasts the Chinese coffee market
to grow at a CAGR of 26% over FY2018-23. However, we feel some of the
assumptions behind the market growth to be far too optimistic. The report
assumes the average price per cup to increase at a CAGR of 12% over
FY2018-23, However, we feel it will be a bit difficult given the increased
competition and the slowdown in the Chinese economy. Furthermore, the
analysis of the below charts also suggests that post FY2019 pricing needs to
pick up pace in order to meet the industry growth trajectory.
Chinese Coffee Industry Growth
Source: Frost & Sullivan Report
Pricing to Growth to Speed up After 2019
Freshly Brewed Coffee Growing Faster
As Luckin Coffee operates in the fresh coffee segment it's important to

isolate fresh coffee growth from the overall industry growth. Fresh coffee is
expected to grow at a CAGR of 32% over FY2018-23 which is about 600bps
above the overall industry growth. Unlike the overall growth which comes
equally from both the price and volume side, in the fresh coffee segment
growth comes primarily from the volume as the price is only expected to
grow at a CAGR of 2% over FY2018-19.
China Coffee Market Still Small Compared to Big Coffee Markets
Growth prospects for the Chinese coffee industry look promising as there is
a long term trend towards the growth of coffee consumption in China.
However, even with these rapid growth projections, China’s coffee
consumption will be very low compared to the rest of the major coffee
consumers. We believe China will get there eventually, but it will take them
more than another 5-10 years.
China despite being an economic powerhouse, only accounts for about 2% of

the global coffee market. Even if this rapid growth continues, we expect it
will take another 15-20 years minimum for the Chinese coffee market to
reach the size of the US coffee market.
This is mainly due to the lower per capita consumption of coffee in China
compared to the bigger coffee markets. However, the per capita consumption
is on the rise as the fresh brew per capita consumption is expected to grow at
a CAGR of 28% over FY2018-23. Yet FY2023 China per capita coffee
consumption will remain at less than 3% of the current US per capita coffee
consumption.
Per Capita Coffee Consumption in China
Comparison between Countries: Per Capita Coffee Consumption in 2017
Source: Statista
New Coffee Shop Openings: Competition Expected to Intensify
The number of offline coffee shops in China has grown at a CAGR of 28%
over FY2012-18. The industry volume (no of cups) growth was more than
enough to support the new store openings. But over the last couple of years,
Industry volume growth has slowed down a bit, and the new coffee shops
growth rate has also slowed down. However, the growth rate of new coffee
shops remains higher than industry volume growth indicating that the
competition will be fierce in the coming years.
Industry Volume Growth vs New Coffee Shops CAGR
Source: Statista & Frost & Sullivan Report
Despite this, there seems to be no slowdown of new coffee shop openings

from Luckin Coffee, Starbucks China, Costa Coffee or Tim Hortons as they
plan to expand their coffee shop portfolio in China at a rapid pace. Luckin
wants to be the market leader by the end of 2019 with 4,500 coffee shops.
Beyond that, if they are to maintain the leadership position, they would have
to match Starbucks coffee shop openings. Starbucks plans on having 6,000
coffee shops in China by 2022 and to get that number up to 10,000 by 2027.
Costa Coffee and Tim Hortons are also planning on increasing their coffee
shop network at a rapid pace over the next 5 years. Thus, we expect industry
volume growth to lag behind coffee shop openings over the next 3-5 years
thereby intensifying competition among the industry players.
Luckin Taking a Different Approach from Starbucks
As Luckin Coffee was late to the party, they had to take a different approach
from Starbucks to take advantage of the growing coffee consumption trend
in China. Starbucks took a measured approach in China as they expanded in
a slower but steady and disciplined manner over the last 20 years. On the
other hand, Luckin had to catch up the 20 years of work Starbucks had put in
in China. So, they couldn’t afford to go slow. Thus, the company went all out
with their expansion and opened up more than 2,300 coffee shops in China
within less than 2 years.
Starbucks didn’t go and open up coffee shops without proper due diligence.
They spend time and effort in selecting locations for coffee shop openings
whereas Luckin didn’t have the same amount of time and resources as
Starbucks. They were too focused on somehow opening up new stores to
reach their target of being the number 1 coffee chain in China.
Coffee Consumption of Chinese People is Not Ready for Luckin’s

Strategy to Be Successful
All of Luckin’s coffee shops are spread across just 28 cities while Starbucks
operates in about 150 cities in China. Hence, if we look at a metric such as
the number of coffee shops per every 100,000 residents in a particular city,
we believe Luckin has a significantly higher number than Starbucks. Thus,
limiting the no of potential customers per coffee shop.
This strategy of having many coffee shops in one city or area may well work
in countries and cities where per capita coffee consumption is significantly
higher than China. Although the Chinese per capita coffee consumption is
growing at a rapid rate as we mentioned above, it will take a long time to
reach the levels needed for Luckin’s strategy to be successful.
Luckin may Run Out of Luck before China is Ready
Luckin relies heavily on discounts to attract and retain their customer base.
And we believe the constant discounts that Luckin has given to its customers
since inception has created an expectation among the customers that
discounts are almost certain with all purchases.
Also, the company boasts about its app and the quality of its coffee,
however, we feel that none of it gives the company an edge over the
competitors. Reading the customer reviews, we feel the only differentiator is
the discounted price as most reviewers preferred Starbucks coffee over
Luckin but they bought Luckin coffee because the net price after all the
discounts and coupons were significantly cheaper than Starbucks.
However, we feel Luckin may find it difficult to sustain the discounts as the
company is burning money even at a cash gross margin level (excluding
depreciation)
Source: Company Disclosures
Also, with competition expected to get worse in the coming years, and with
an already weak balance sheet which is getting weaker every day, Luckin will
require more and more capital to stay afloat unless the company manages to
turn things around soon and start generating cash returns.
On the other hand, Luckin’s competition is more well-resourced and is

capable of competing with Luckin’s prices until Luckin burns through all its
resources and goes out of business. Furthermore, Starbucks has the brand
name and perceived quality which alone is enough to compete with Luckin’s
undercut pricing strategy.
Results: Mixed Signals About Growth and Sustainability
Luckin financials have shown signs of a slowdown in 1QFY2019 and the

company is mentioning that this is down to the seasonality of their business.
With a limited history, it's difficult to know whether the slowdown is really
down to seasonality or due to any other fundamental flaws of the business
model.
On the other hand, our analysis of Starbucks China results shows very little
to no impact from seasonality. While Luckin’s quarterly revenue per coffee
shop decreased 25% QoQ in the 3 month period ended March 2019,
Starbucks showed an increase of close to 5%. Thus, seasonality is limited to
Luckin and it could be due to the reliance on placing a majority of its coffee
shops mainly in commercial buildings such as office space.
Source: Statista
We believe apart from seasonality there are other factors behind the
slowdown in 1QFY2019 performance. The average price per cup of Luckin
Coffee increased 7% QoQ in 1QFY2019. We believe this is primarily down to
lower discounts offered by the company as sales are recognized net of
discounts. Thus, we believe customers have reduced their purchases of
Luckin Coffee as they find the price is not attractive enough to purchase
Luckin compared to Starbucks or other competing products.
Increase in Average Price Per Cup May have had an Impact on Sales Volumes
As a result, despite the increase in average price, average revenue per

restaurant is down 25% in 1QFY2019.
The number of transacting customers has seen rapid growth since the
formation of the company and in 1QFY2019, despite the aforementioned
seasonality, this has grown by more than 34% QoQ to reach 16.9m
customers. Although the growth is lower than the previous quarter’s 109%,
we believe on a per new coffee shop basis 1QFY2019 customer additions to
be superior than 4QFY2018 as Luckin only added about 300 new coffee shops
in 1QFY2019 whereas it was more than 880 new coffee shops in 4QFY2018.
Focus on New Customers Acquisitions Results in Losing Out on Their

Existing Customers
On the other hand, when Luckin focused its discounts, advertising and
promotional spending towards new customers, we believe that they have lost
out with their existing customers. As we mentioned earlier customers are
with Luckin Coffee due to its discounts. We believe most of the discounts
and promotional expenses in 1QFY2019 were focused on new customers
rather than on the retention of their existing customers. As a result, the
discounts would have been reduced or cut for existing customers to spend
them on new customer acquisition instead. Therefore, we believe the
average price per cup increase would have been even more than 7% QoQ for
the existing customers.
We believe, the decreasing discounts for the existing customers would have
also been a major contributor to the slowdown in the number of transacting
customers as opposed to seasonality like the company has mentioned.
No Growth in Average Monthly Transacting Customers Despite the Addition

of about 4m New Customers
Furthermore, Luckin’s focus on new customers is hindering its own success

as indicated by the declining monthly transacting customers per store,
which decreased more than 25% QoQ in 1QFY2019. On the other hand, new
customers aren’t as consistent as their pervious customer base. Thus, the
average monthly cups per customer has also been on the decline over the
last two quarters.
Pressure on Luckin to Generate Volume Growth amid Declining Average

Monthly Cups Per Customer
Declining Customer Acquisition Cost?
The company talks about declining customer acquisition cost. But we feel
the calculation of customer acquisition cost ignores two main costs
associated with customer acquisition. First of all, it ignores the higher than
usual discounts given to attract new customers as the discounts are
deducted from the selling price. Furthermore, it takes into account all the
transacting customers rather than only considering the ones the company
managed to turn into monthly transacting customers. We believe most of

the customers just register with Luckin to get the discounts and never return
once the discounts/coupons/ free coffees are done. Thus, we believe the
calculation of acquisition cost shows a misleading picture to investors.
New Customers vs the Increase in Monthly Transacting Customers
Source: Company Disclosure
Luckin may Struggle to be Profitable While the Chinese Coffee Market

is in its Infancy
Luckin’s has opened up many coffee shops in a few cities rather than going
about it in a much more selective and disciplined manner. We believe
Luckin’s approach would have worked in a more mature coffee market where
people drink more coffee than tea, as it would enable the coffee shop to sell
more cups per customer.
So, we believe the coffee shops in China would need to attract more
customers per store than the ones in a mature coffee market in order for
them to be profitable. Hence, we believe having more coffee shops close to
each other would be negative in China until the Chinese coffee market
matures.
As previously mentioned Luckin is burning through its capital to expand its

coffee shop portfolio with the aim of becoming the largest coffee shop chain
in China. Without profits to show for we feel that even if Luckin achieves its
targets by the end of FY2019 and become the largest coffee shop chain in
China its number one status will be very short-lived.
Not Serving Enough Coffee to be Profitable
Luckin’s average revenue per coffee shop stands at just below 15% of that of
Starbucks China. Even with significantly higher revenue per store Starbucks
only generates about 18% EBIT in the whole China/Asia Pacific region and
out of the whole region we believe that China may be having the lowest EBIT
margin.
Even after stores mature, we believe Luckin will have significantly lower
revenue per coffee shop compared to Starbucks. Thus, the likelihood of
Luckin’s margin getting even close to Starbucks China’s margin is remote.
Comparison of Revenue Per Coffee Shop
Furthermore, Luckin’s pricing is significantly (about 30%) lower than

Starbucks. But when discounts/coupons are taken into account, we believe
the pricing discount further expands as the price of a Luckin Coffee is just
about 1/3 of the price of a similar Starbucks product. However, even with
those deep discounts, they don’t seem to serve at least the same number of
customers that a Starbucks coffee shop would serve. This creates a huge
revenue per store disparity which we feel is difficult to overcome.
On the other hand, these deep discounts are costing the company money as
they operate at a gross loss. And as mentioned earlier, with competition
stiffening and consumer perception that the discounts are a given with
Luckin, the company will find it difficult to reduce the discounts or increase
prices.
Thus, it is very difficult for the company to increase its revenue per coffee
shop up to Starbucks China levels. On the other hand, even if the company
manages to up its revenue per coffee shop to Starbucks levels we are not
quite certain that the company will be able to generate profits as Luckin’s
pricing is at a steep discount to Starbucks.
Thus, we believe Luckin would have to generate revenue per coffee shop
higher than that of Starbucks China to even generate margins similar to
Starbucks. We do not consider this a realistic proposition.
How Many of the Restaurants are Making Money?
Although there are signs of improvement, store level operating results

(defined by the company) are still negative. To our understanding what’s
more important to the investor is not the aggregate store level operating
result. Instead, if the company can give a summary of the performance of
their mature coffee shops, such as revenues, customer and transaction
numbers and more importantly the profitability it would be a massive help

for the investors who are still unsure of the business strategy of Luckin
Coffee.
For the moment, we feel if Luckin are to continue with their expansion they
will exhaust all their capital and could risk running out of business before
they can start generating returns.
Loss Per Coffee Shop on the Decline
IPO – Shareholders Would Demand Returns
With the IPO, shareholders would demand a more controlled expansion

which we believe to be beneficial for the company. Also, the shareholders
would require returns sooner rather than later. Hence, the mature stores not
contributing to earnings would not get a long time turn things around.
Although the company to date hasn’t seen any store closures during the
small timeframe that it has been in operation, we feel it’s only a matter of
time as the new investors would require underperforming stores to turn
things around or risk closing down.
Foreign Listing (IPO) at an Early Stage
It makes us wonder why the company is going ahead with an IPO after being
in operation for just a couple of years and given the fact that they are going
overseas with it makes us think even more. With a reasonably developed
private equity market place in China, it would have been easier and faster for
Luckin Coffee to raise money through a private equity deal. However, they
have chosen to go ahead with a foreign listing at a very early stage in the
business. This raises further concerns about Luckin Coffee and the viability
of its business.
At a valuation of around USD3.7bn
Luckin Coffee expects to raise about $800m from an IPO which values the
company at around the $3.7bn range. The previous funding round which was
in mid-April 2019 valued the company at around $2.9bn and we believe with
the capital infusion of another $800m through the IPO would value Luckin
Coffee at somewhere around $3.7bn. Further details about the offering are
yet to be disclosed and we will provide an update once those extra details are
out.
For the moment a valuation of around $3.7bn implies a forward EV/Sales

multiple of over 10.0x and a P/B of more than 13.0x. These multiples are
expensive especially considering the unproven nature of Luckin’s business
model.
On the other hand, Starbucks has years and years of success behind them
and provides the investors with an opportunity to access the boom in
Chinese coffee consumption at a fraction of the risk compared to what
Luckin Coffee provides. Also, Starbucks trades at 3.7x Forward EV/Sales
which is significantly cheaper than Luckin Coffee. Thus, we’d recommend to
stick with Starbucks for both your coffee and money.

— Oshadhi Kumarasiri (26 Apr 2019)
Luckin Coffee (瑞幸咖啡) - Base Case Valuation - Cheap Coffee Expensive Company

啡) - Base Case
Valuation - Cheap
Zhen Zhou, Toh
Coffee Expensive
Company
By Zhen Zhou, Toh | 02 May 2019
• Luckin Coffee (瑞幸咖啡) Vs. Starbucks (星巴克) - Still Has a Long Way
to Go
In this insight, we will compare Luckin Coffee and Starbucks' operating

costs, derive the valuation of Luckin based on our forecast of its operating
metrics, and compare it with the valuation from its pre-IPO investments and
Starbucks' East China acquisition.
D E TA I L
Cost comparison between

Starbucks and Luckin
Before getting into the valuation, we compare the costs breakdown of Luckin
and Starbucks. Even though the figures used here for Starbucks are on the
company level, not China, it gives a good sense of what Luckin's target
margins could be at and where it can look to cut costs in the future.
The details are provided in the table below. The key takeaways are:
Zhen Zhou, Toh 46

For every dollar of revenue earned,
• 63% and 41% flows to cost of material/cost of sales for Luckin and
Starbucks respectively. The cost recognition here varies between the
two company whereby Starbucks included its occupancy cost in the cost
of sales while Luckin splits the cost out into a different line item, store
rental and other operating costs.
• 69% of Luckin's revenue is paid to store rental and other operating costs
whereas, for Starbucks, we included their store operating expenses and
other expenses. Note that these expenses are not included in the
occupancy cost in the cost of sales; they are separate costs line items.
• On sales and marketing, Luckin spends about 89% of its revenue on ads,
free promotion, and delivery, whereas Starbucks only spends a tiny 1%
on ads.
• Finally 45% of the revenue flows into general and admin costs for
Luckin while Starbucks maintains it at 7%.
• Luckin is still very very far from operating on Starbucks' level. The
immediate costs that Luckin needs to cut is its sales and marketing
expenses, spending less on ads and delivery but, at the same time, the
key thing it needs to focus on is how to raise the price of its coffee.
Category (as pct of total revenue) Luckin Starbucks
Total revenue (USDm) 126 24,720
Cost of material/cost of sales 63% 41%
Store rental and other operating costs 69% 31%
D&A 13% 5%
Sales and marketing expenses 89% 1%
G&A 45% 7%
Total operating expense as pct of revenue 290% 86%
Operating income margin -190% 16%
EBITDA margin -177% 21%
Net margin -193% 18%
In our view, Luckin will not be able to operate on Starbucks'

profitability level any time soon. In fact, it probably will not be
profitable at all, any time soon. Hence, it doesn't make sense to
model Luckin's valuation based on profitability. Instead, in the
following segment, we will focus on revenue projection and value the
company on revenue multiples.
Zhen Zhou, Toh 47

Base case valuation
The table below shows the key growth assumptions.
Key growth assumptions made Jun-18 Sep-18 Dec-18 Mar-19 FY2019E

QoQ QoQ QoQ QoQ YoY
Growth Growth Growth Growth Forecast
Growth assumption of customers per store 120% -22% 28% -25% 9%
Growth assumption of no. of drinks bought per 23% 7% -6% -4% 5%

customer
Growth assumption of no. of food bought per 7% 285% 19% -26% -6%
customer
Growth assumption of ASP of drinks 27% 15% -17% 7% 6%
Growth assumption of ASP of food -16% -32% -3% 21% -11%
Growth of no. of stores 115% 91% 74% 14% 105%
Revenue growth 838% 98% 93% 3% 285%
The rationale for the assumptions is as follows and the table for the
implied operating metrics is below:
• Number of customers per store: We assumed that the average

number of customers that Luckin can attract on a per store level will
grow by 9% YoY from 71.39 in FY2018 to 77.89 in FY2019E. Even though
the headline numbers imply a YoY growth, we have actually assumed
that Lucking will not grow its number of customers per store on a YoY
basis for the remaining three quarters of the year.
◦ The growth assumption here is justifiable because if we omit the

March 2018 data, Luckin has been showing no growth in its
average daily customers as shown in the chart below. The
company's average quarterly daily customers have fluctuated
between 88 - 60 after March 2018.
◦ Note that in the calculation we have used the average monthly

transacting customers per quarter divided by the average number of
stores between the beginning and the end of the quarter.
Zhen Zhou, Toh 48

• Average daily number of drinks bought per customer: We assumed

that the average daily number of drinks bought per customer will gain
modestly by 4% YoY for FY2019E. The rationale of the growth
assumption is the same as the growth for the number of customers,
implying that there is no growth in the number of drinks bought per
customer in the remaining three quarters of the FY2019E.
• Average selling price (ASP) of drinks and food items: In our view,
pricing will continue to be a problem as customers are used to
discounted prices on their drinks and food, hence, we assumed that
there will only be a modest 6% YoY increment of ASP of drinks for
FY2019E with the same rationale of no growth in the next three
quarters. On the other hand, considering that Luckin's focus is still on
beverages, we forecast an 11% drop ASP growth for food.
Zhen Zhou, Toh 49

• Number of stores: We assumed that the number of stores will grow by

2,500 from the 2,370 stores it reported in 3M FY2019, in line with the
company's planned expansion mentioned in media reports.
• Reason for assumptions: Our base case assumption reflects the

problem that Luckin will face, which is brand loyalty. As per our
channel check earlier and the previous insight, Starbucks is basically
offering the same services as Luckin (delivery) and Luckin is left to
compete on price. We note that our assumption models only a modest
6% YoY ASP appreciation for FY2019E and implying no growth for the
next three quarters, suggesting that pricing power is lacking due to
poor brand loyalty.
• Daily drinks and food revenue per store: Multiplying the average
daily number of customers per store by the average number of drinks
and food bought per customer, the average daily number of drinks and
food items sold per store is derived. Using this figure, multiplied by the
ASP for drinks and food items, we arrive at the daily drinks and food
revenue per store.
Implied operating metrics FY2018 FY2019E
Avg daily no. of customers per store - [a] 71.39 77.89
Avg daily no. of drinks bought per customer- [b] 2.97 3.12
Avg daily no. of food items bought per customer- [c] 0.73 0.68
Avg daily no. of drinks bought per store- [a] * [b] = [d] 212.07 243.15
Avg daily no. of food items bought per store- [a] * [c] = [e] 51.87 53.30
Average selling price per drinks (RMB)- [f] 8.74 9.27
Average selling price per food items (RMB)- [g] 9.67 8.59
Average daily drinks revenue per store (RMB)- [d] * [f] = [h] 1,853 2,255
Average daily food revenue per store (RMB)- [e] * [g] = [i] 501 458
No. of new stores opened 1,802 2,500
No. of stores 2,370 4,870
Revenue (RMBm) - ([h]*365 + [i] * 365)*AVG(stores) 841 3,240
Zhen Zhou, Toh 50

• Based on these forecast figures, we work out Luckin's FY2019E revenue

to be RMB3.2bn (or US$481m) by multiplying the average daily revenue
per store by 365 days and the average number stores between the
beginning and end of the quarter and summing them up.
• As a sanity check, Starbuck's China revenue as of Q2 quarter FY2019

(ending March) was about US$700m which works out to be an
annualized figure of US$2.8bn.
• Based on our cost assumptions (assuming rental and operating costs

growing in tandem with store growth), Luckin will still be making
operating losses in FY2019E. Hence, we opted to value the company on
FY2019E EV/Revenue multiples.
Company name Price MCap EV/EBITDA EV/S Rev Growth (19E,

(US$m) (19E) (19E,x) %)
Luckin Coffee - - - - 285%
Simple Avg (Excl 18.3 2.7 27.7

Starbucks)
Starbucks 77.68 96,603 18.2 3.8 6.2
Yum China 47.54 18,016 12.1 2.0 5.7
Haidilao 30.20 20,402 29.2 5.1 58.6
Xiabuxiabu 13.80 1,893 11.6 1.9 25.9
Jollibee Foods 304.60 6,427 20.3 1.9 20.8
• Since Luckin is still growing rapidly (much faster than peers on revenue
growth basis), we assumed a 20% premium over the peer average EV/
Revenue, which implies FY2019E 3.3x.
• This would imply that Luckin is valued at a discount to Starbucks but at

a premium to peers (excluding Starbucks) which we think is fair
considering that the latter is the global coffee industry leader.
• Under these assumptions, Luckin is valued at RMB10.6bn EV and

adding net cash from its balance sheet, including BlackRock's
Investment of US$150m, we will arrive at a pre-money valuation
of RMB12.4bn (or US$1.9bn).
• We also included valuation pegged at the different multiples peer

multiples in the table below. Pegged at Starbucks FY2019E EV/Revenue
values the company at just US$2.1bn while valuing at Haidilao's EV/
Revenue of 5.1x gives a valuation of US$2.7bn.
• Other things to note: Luckin will have to sell its drinks at ASP of RMB14 in
FY2020E to turn profitable on an operating level.
Base case (FY2019E Revenue)
Pegged to Pegged to Pegged to lowest Pegged to 20% premium

Starbucks highest (Xiabuxiabu) to peer average
(Haidilao)
FY2019E Revenue of Luckin 3,240 3,240 3,240 3,240

(RMBm)
Peer average FY2019E EV/ 3.8 5.1 1.9 3.3

Rev
Implied EV of Luckin 12,467 16,641 6,177 10,584
Net debt + Blackrock -1,805 -1,805 -1,805 -1,805

investment
Zhen Zhou, Toh 51

Implied Mkt cap of Luckin 14,272 18,446 7,981 12,388

pre-money (RMBm)*

pre-money (USDm)*
Sanity checks
East China transaction

We used Starbucks' recent acquisition of its remaining stake in its East China
joint venture from Uni President Enterprises Corp (1216 TT) and President
Chain Store (2912 TT) as sanity checks. The acquisition consideration was
US$1.3bn for the remaining 50% stake in the JV, valuing the company at
US$2.6bn. The acquisition added about 1,300 stores for Starbucks and the
valuation per store works out to be US$2m.
Comparing by the average daily number of customers per store between

Luckin and Starbucks, Luckin's stores should be valued at a 76% discount to
Starbucks as shown in the table. This is in line with our expectation that
Luckin's store, being mostly pick-up stores, serve fewer customers and have
lower average revenue per store than Starbucks. Based on that, we arrive at a
valuation of US$2.7bn for Luckin.
Category Amount
Transaction amount (USDm) 1,300
Ownership (%) 50%
Valuation of East China stores (USDm) 2,600
No. of stores added 1,300
Valuation per store (USDm) 2
Avg. daily no. of customers per store for Luckin 71
Avg. daily no. of customers per store for Starbucks (low-end of media report) 300
Discount per store (%)* 76%
No. of stores at end of FY2019E 4,870
Valuation of Luckin based on FY2019E no. of stores 2,305
Pre-IPO investors - valuation based on

BlackRock's investment
We work out that the average cost per share of BlackRock's investment is
about US$150m in Series B-1 which was completed mid-April just before the
company filed its prospectus with the SEC.
Zhen Zhou, Toh 52

Series Investing entity Number Amount Cost per Date of

funding of shares (USDm) share funding
round (USD)
angel-1 Primus Investments, Mayer Investments, Star 915,750 122 133 6/29/
Grove 2018
angel-2 Haode Investment 513,000 68 133 6/29/

2018
Series A Lucky Cup, Joy Capital II, Joy Luck Management, 544,688 200 367 6/29/
Galaxy Shine, Haode Investment, Carob 2018
Series B Fortunate Cup, Joy Capital II, Honour Ample, Joy 272,343 200 734 11/15/
Luck, Carob, Blue Fortune 2018
Series B Galaxy Shine 6,809 5 734 1/9/

2019
Series B-1 BlackRock 172,182 150 871 4/17/

2019
Using the cost per share and the number of ordinary shares as per the
prospectus (which assumes all preferred shares are converted on 1:1 basis),
we arrive at a valuation of US$2.7bn which is almost the same as our
valuation based on Starbucks' East China transaction.
Category Amount
Total number of ordinary shares outstanding (as of prospectus date) 3,175,772
Latest transaction price per share (USD) 871
Valuation (USDm) 2,767
Conclusion
Luckin is expensive based on FY2019E forecast. Valuation of the
company based on latest investment round was US$2.7bn versus our
valuation of US$1.9bn based on a 20% premium over FY2019E peer
average EV/Revenue.

Zhen Zhou, Toh 53

Luckin Coffee (瑞幸咖啡) - Blue-Sky/Bear-Case Valuation

啡) - Blue-Sky/Bear-
Case Valuation
Zhen Zhou, Toh

to Go
• Luckin Coffee (瑞幸咖啡) - Base Case Valuation - Cheap Coffee

Expensive Company
In this insight, we will derive the valuation of Luckin Coffee based on

optimistic and bearish assumptions.
D E TA I L
Bull case - if it achieves full

potential
This insight is a continuation of our previous note, Luckin Coffee (瑞幸咖啡)

- Base Case Valuation - Cheap Coffee Expensive Company. The blue sky
assumptions here will be built upon the forecast we have made previously,
hence, we would recommend reading that note first.
In our previous insight, we thought that the company will continue to be

unprofitable in the near term and Luckin was expensive based on FY2019E
forecasts. In this insight, we will assume optimistic growth and operating
metrics to get an understanding of the potential of Luckin if it is able to
achieve stronger pricing power
Zhen Zhou, Toh 54

Key growth assumptions made FY2019E
Growth assumption of customers per store 40%
Growth assumption of no. of drinks bought per customer 24%
Growth assumption of no. of food bought per customer -6%
Growth assumption of ASP of drinks 140%
Growth assumption of ASP of food -11%
Growth of no. of stores 105%
Revenue growth 934%
The rationale for the assumptions is as follows and the table for the
implied operating metrics is below:
• Average daily number of customers per store: We assumed Luckin

will serve an average of 100 customers per store everyday for FY2019E.
We benchmark this at one-third of Starbucks' 300 daily average
customers served (based on media reports of 300 - 500).
• Average daily number of drinks bought per customer: We assumed

that the average daily number of drinks bought per customer will
increase by 23.5% YoY, which is in line with the forecast CAGR of coffee
consumption in first and second tier cities in China as per the industry
report in the provided in the prospectus.
• Average selling price (ASP) of drinks and food items: For the sake of
understanding Luckin's potential, we assumed that Luckin will be able
to sell its drinks at the average full retail price (FRP) of an Americano
which is RMB21. On the other hand, we assumed ASP of food items to
be the same as our base case valuation. The strong ASP increase implies
that Luckin has managed to achieve strong pricing power, allowing it to
taper off discounts.
• Number of stores: We keep the forecast for the number of stores the
same which is in line with the company's planned expansion mentioned
in media reports. There is no reason to build in a more optimistic
forecast here since it already implies that store count will double.
Avg selling price per drinks (RMB)- [f] 8.74 21.00
Avg selling price per food items (RMB)- [g] 9.67 8.59
Avgdaily drinks revenue per store (RMB)- [d] * [f] = [h] 1,853 7,705
Avgdaily food revenue per store (RMB)- [e] * [g] = [i] 501 588
Zhen Zhou, Toh 55

• Based on these forecast figures, we work out Luckin's FY2019E revenue

to be RMB8.7bn(or US$1.3bn) by multiplying the average daily revenue
per store by 365 days and the average number stores between the
beginning and end of the quarter and summing them up.
• We derive valuation by EV/revenue (to be consistent with our previous

valuation methodology in base case). At a 20% premium to peer
average, the company is valued at US$4.5bn valuation (including
BlackRock's investment).
Bull -case (FY2019E Revenue)
Category Pegged to Pegged to Pegged to lowest Pegged to 20%

Starbucks highest (Xiabuxiabu) premium to peer
(Haidilao) average
EV/Revenue

(RMBm)

Rev

investment

pre-money (RMBm)*

pre-money (USDm)*
• In fact, with these assumptions, we calculate that Luckin will achieve

profitability with EBITDA and PATMI at RMB2bn and RMB1.7bn, which
translates 69% gross margin and 20% net margin.
• At these profitability levels, the company is actually more profitable

that Starbucks which is operating at 18% net margin as of FY2018 but
slightly behind Starbucks' 21% EBITDA margin.
The blue-sky valuation shows the potential of Luckin but it also

implies that investing in Luckin is basically betting that 1) Chinese
will increase consumption of coffee and 2) Luckin can build stronger
pricing power which will allow them to increase their ASP of drinks.
In our view, Luckin is still at its nascent stage. One could probably
still argue that coffee consumption will increase in the next couple of
years since it is relatively much lower than other Asia Pacific
countries. But, pricing power is something that seemed fleeting so
far based on the operating metrics as it continues to sell heavily
discounted coffee.
Zhen Zhou, Toh 56

Bear case
Key growth assumptions made FY2019E
Growth assumption of customers per store -7%
Growth assumption of no. of drinks bought per customer 0%
Growth assumption of no. of food bought per customer -6%
Growth assumption of ASP of drinks -19%
Growth assumption of ASP of food -11%
Growth of no. of stores 105%
Revenue growth 176%
• In our bear case valuation, the main changes we have made is lowering
the average daily number of customers per store to 1Q FY2019
customers of 66.05 which is the lowest in the last four quarters
implying that Luckin failed to achieve pricing power.
• We also reflect this change in terms of the fall in ASP of drinks down to
its 4Q FY2018 ASP of RMB8.6 (lowest in the last four quarters), which
imply that the company has to rely on heavily discount coffee to
continue to sell its coffee.
• For other metrics, we assumed no growth from FY2018 while the

number of stores will still increase by 2,500 because the company will
likely still try to increase its foot print in spite of the poor traction.
Average selling price per drinks (RMB)- [f] 8.74 7.07
Average selling price per food items (RMB)- [g] 9.67 8.59
Average daily drinks revenue per store (RMB)- [d] * [f] = [h] 1,853 1,386
Average daily food revenue per store (RMB)- [e] * [g] = [i] 501 388
• From these figures, we derive an RMB2.3bn FY2019E revenue for

Luckin. At RMB7.07 average ASP per drink, we estimate that the
company will burn through about RMB3.1bn in cash in FY2019E.
• Using the same peer group and the same EV/Revenue peg, we arrive at a
valuation of US$1.5 for Luckin. We think the valuation in this scenario
is already very bullish considering that it has lost pricing power as
shown in the operating metrics.
Zhen Zhou, Toh 57

Bear case (FY2019E Revenue)
Category Pegged to Pegged to Pegged to lowest Pegged to 20% premium

Starbucks highest (Xiabuxiabu) to peer average
(Haidilao)

(RMBm)

Rev

investment

pre-money (RMBm)*
Implied Mkt cap of Luckin 1,612 2,061 935 1,409

pre-money (USDm)*
Valuation of all scenarios

Scenarios Blue-sky Base Bear
Revenue 8,693 3,240 2,323
Multiple (x) 3.3
Reason Pegged to 20% premium to peer average
Implied EV (RMBm) 28,395 10,584 7,590
Implied pre-money mkt cap (RMBm) 30,200 12,388 9,394
Implied pre-money mkt cap (USDm) 4,530 1,858 1,409
Conclusion
The bull-case valuation is probably impossible to achieve in the
near-term but we get a glimpse of what the valuation could be if the
company pulls it off. The main takeaway here is that Luckin will need
to get a lot of things right to command that kind of valuation.
We have labelled this insight bearish despite Luckin's potential
because we think that it has yet to show that it can achieve pricing
power amidst heavy discounting of its coffee and rapid store
expansion.
Zhen Zhou, Toh 58


— Zhen Zhou, Toh (02 May 2019)
Zhen Zhou, Toh 59

Luckin Coffee (瑞幸咖啡) IPO Review - Marketed Valuation Is Closer to Our Blue-Sky Scenario

啡) IPO Review -
Marketed Valuation Is
Zhen Zhou, Toh
Closer to Our Blue-Sky
Scenario
We've already covered most aspects of the company and our thoughts on
valuation in:
to Go

Expensive Company
• Luckin Coffee (瑞幸咖啡) - Blue-Sky/Bear-Case Valuation
In this insight, we will value the company based on our base case
assumptions and compare it to peer multiples.
D E TA I L
Deal and framework score overview
Regular readers will be familiar with the below embed from our IPO tool
which has been designed to provide you with timely information on all IPO
related events (Book open/closing, listing, initiation, lock-up expiry, etc) for
all the deals we have worked on.
Note that we have included the concurrent placement to Louis Dreyfus.
Zhen Zhou, Toh 60

Our take on the deal
Peer valuation at FY2019E

Using the same assumptions in our base case valuation, Luckin Coffee (瑞幸
咖啡) - Base Case Valuation - Cheap Coffee Expensive Company, we project
Luckin's FY2019E revenue to be about RMB3.24bn. The implied enterprise
value (EV) is about RMB18.5 -21.2bn based on the IPO price range (including
cash from BlackRock's investment).
We use a mix of China F&B companies, international emerging quick service

restaurant, and Starbucks as peers for comparison of valuation. Luckin is
offered at 5.7 - 6.54x FY2019E EV/Revenue compared to the peer average of
3.64x which implies a 36 - 44% potential downside. Compared to Starbucks,
valuation is also implying a 32 -41% downside while comparison with
Haidilao implies 17 - 27% potential downside.
Company name Price MCap (US$m) EV/S (19E,x) Rev Growth (19E, %)
Low End Pricing 15.00 3,488 5.70 398.8
High End Pricing 17.00 3,954 6.54 398.8
Mcap Weighted Avg 3.64 14.4
Starbucks Corp 78.06 94,546 3.87 6.2
Yum China 46.50 17,624 2.02 6.0
Haidilao 29.00 19,592 4.74 58.6
Xiabuxiabu 12.98 1,781 1.77 25.9
Jollibee Foods 302.00 6,342 1.85 20.8
FY2020E valuation
FY2019E valuation looks grossly overvalued. However, if we extend our

assumptions to FY2020E, we get a valuation that is slightly more sensible.
FY2020E assumptions are explained below.
We forecast Luckin's FY2020E revenue to be about RMB6.2bn which implies

that Luckin is offered at 2.83 - 3.24x FY2020E EV/Revenue. This puts the
company in line with the peer average of 3.25x EV/Revenue at the top end
and some 15% potential upside from the bottom end.
Company name Price MCap (US$m) EV/S (20E,x) Rev Growth (20E, %)
Low End Pricing 15.00 3,488 2.80 101.6
High End Pricing 17.00 3,954 3.22 101.6
Mcap Weighted avg 3.25 12.0
Starbucks Corp 78.06 94,546 3.60 7.6
Yum China 46.50 17,624 1.89 6.9
Zhen Zhou, Toh 61

Haidilao 29.00 19,592 3.47 36.7
Xiabuxiabu 12.98 1,781 1.47 20.5
Jollibee Foods Corp 302.00 6,342 1.64 12.6
Alternatively, we can also assume that Luckin will trade at a discount to

Starbucks, considering that Starbucks have successfully built a global brand
and a much longer history compared to Luckin which is still in its nascent
stage. At 20% discount to Starbucks, Luckin would have almost no upside
from the bottom end of its price range.
Premium 0% 10% 20%
Implied upside from low-end of IPO price range 28% 15% 3%
Implied downside/upside form top of IPO price range 12% 1% -10%
FY2020E fair value implies 5%

downside
Keeping our valuation methodology consistent with our base case scenario
note, we peg Luckin's FY2020E revenue to a 20% premium of peer average
(excluding Starbucks) which works out to be FY2020E EV/Revenue of 2.53x
and EV of RMB16.7bn. Adding cash, proceeds from BlackRock investment
and IPO, we arrive at an implied market cap of US$3.3bn, about US$14.23 per
ADS, implying a 5% downside from the bottom end of the IPO price range.
Scenario Base
Revenue 6,585
Multiple (x) 2.53
Implied EV (RMBm) 16,669
Implied mkt cap (RMBm) 22,067
Implied mkt cap (USDm) 3,310
Price per ADS (USD) 14.23
Our assumptions for FY2020E are as follows. Overall, we forecast that

most of the operating metrics will continue improve in FY2020 as we expect
more stores to mature and the new store openings to weigh less on the
average.
Key growth assumptions made Jun-18 Sep-18 Dec-18 Mar-19 FY19E FY20E
Growth assumption of customers per store 120% -22% 28% -25% 9% 10%
Growth assumption of no. of drinks bought per 23% 7% -6% -4% 5% 5%

customer
Growth assumption of no. of food items bought per 7% 285% 19% -26% -6% 10%
customer
Growth assumption of ASP of drinks 27% 15% -17% 7% 6% 6%
Growth assumption of ASP of food items -16% -32% -3% 21% -11% 0%
Growth of no. of stores 115% 91% 74% 14% 105% 21%
Revenue growth 838% 98% 93% 3% 285% 103%
Zhen Zhou, Toh 62

Considering that the company is growing at breakneck speed, FY2020E

assumptions of operating metrics could easily be distorted. The one most
important metric here is that we have assumed that the company will open
another 1,000 stores in FY2020E to put it on the same scale as Starbucks'
planned expansion of 6,000 stores by FY2023.
Implied operating metrics FY2018 FY2019E FY2020E
Avg daily no. of customers per store - [a] 71.39 77.89 85.68
Avg daily no. of drinks bought per customer- [b] 2.97 3.12 3.28
Avg daily no. of food items bought per customer- [c] 0.73 0.68 0.75
Avg daily no. of drinks bought per store- [a] * [b] = [d] 212.07 243.15 281.04
Avg daily no. of food items bought per store- [a] * [c] = [e] 51.87 53.30 64.49
Average selling price per drinks (RMB)- [f] 8.74 9.27 9.83
Average selling price per food items (RMB)- [g] 9.67 8.59 8.59
Average daily drinks revenue per store (RMB)- [d] * [f] = [h] 1,853 2,255 2,763
Average daily food revenue per store (RMB)- [e] * [g] = [i] 501 458 554
No. of new stores opened 1,802 2,500 1,000
No. of stores 2,370 4,870 5,870
Revenue (RMBm) - ([h]*365 + [i] * 365)*AVG(stores) 841 3,240 6,585
Sanity check - BlackRock's investment

and our buy level
BlackRock invested in Luckin at the valuation of US$2.77bn. This was only
recently completed in April 2019 last month. If we add the IPO proceeds
(including the concurrent placement) to that, it would imply a US$3.3bn
valuation as shown in the table below.
Category Amount
Total number of ordinary shares outstanding 3,175,772
Latest cost per share (USD) 871
Valuation (USDm) 2,767
Valuation including IPO proceeds (USDm) 3,297
Per ADS basis (USD) 14.18
Implied downside from bottom of IPO price range (%) -5%
Implied downside from top of IPO price range (%) -17%
Our forecast fair value sits right between the BlackRock's implied
valuation and the bottom end of the IPO valuation. Hence, in our
view, there are hardly any upside from those levels. For us to be
buyers, there should at least be a 10 - 20% discount to the our fair
value estimate, implying a price range of US$11.40 - 12.80 per ADS
Zhen Zhou, Toh 63

Implied assumptions based on

guided valuation
As per Bloomberg news this afternoon, Luckin was marketed at 1.36 - 1.56x
FY2020E EV/Revenue valuation. We used implied FY2020E revenue to try
to reverse engineered the implied operating metrics that Luckin needs to
operate on to achieve that valuation.
To keep our assumptions consistent, we assumed that the new stores to be

opened to be the same as before; 2500 in FY2019 and 1,000 in FY2020.
We found that if we assumed that the average daily number of customers

served per store would reach 100 by FY2020E in line with our blue-sky
assumptions and assumed a lower ASP growth of drinks (compared to our
blue sky but higher than our base case above), we would arrive at an
FY2020E revenue of RMB13.6bn, in line with the guided valuation.
The guided valuation assumes that Luckin will operate close to our blue sky
scenario which we have modeled in Luckin Coffee (瑞幸咖啡) - Blue-Sky/
Bear-Case Valuation. We think that for Luckin to achieve such a valuation, it
will need to get a lot of things right in a very short period of time.
No. of stores 2,370 4,870 5,870
Key growth assumptions made FY2019E FY2020E
Growth assumption of customers per store 19% 18%
Growth assumption of no. of drinks bought per customer 24% 14%
Growth assumption of no. of food bought per customer -6% 10%
Growth assumption of ASP of drinks 14% 50%
Growth assumption of ASP of food -11% 0%
Growth of no. of stores 105% 21%
Revenue growth 391% 229%
Zhen Zhou, Toh 64

Conclusion
• Luckin Coffee is a fast-growing F&B retailer with a focus on
delivery and takeaway coffee. It only started in October in 2017
and it currently already has 2,370 stores as of March 2019.
• Owing to the short operating history, revenue growth has been

explosive but it has continued to operate at a loss as a result of
its aggressive expansion.
• Our base case valuation indicated that valuation based on

FY2019E assumptions gross overvalues the company on EV/
Revenue,implying 36 - 44% potential downside to peer average.
• Even based on FY2020E forecasts, the implied valuation offers

no upside even from the bottom end of the price range.
• We also find that the guided valuation assumes that Luckin will
operate close to our blue sky scenario. We think that for Luckin
to achieve such a valuation, it will need to get a lot of things
right in a very short period of time.
We would avoid the deal. For us to be buyers, there should at least

be a 10 - 20% discount to the our fair value estimate, implying a
price range of US$11.40 - 12.80 per ADS.

Zhen Zhou, Toh 65

Luckin Coffee IPO: Best Latte Scenario Priced In Unless You See Data Coffee
Luckin Coffee IPO: Best

Latte Scenario Priced In
Unless You See Data
Devi Subhakesan
Coffee
Asia Consumer Research
By Devi Subhakesan | 08 May 2019
Luckin Coffee (LK US) has proposed a price range of USD15 to USD17 per
share for its IPO implying a listing valuation of USD3.5 - USD4 bn. The
indicative valuations may seem more befitting a niche technology startup
than a low-moat mid-tier neighbourhood pick-up coffee chain store. Based
on our analysis of Luckin's coffee business, it appears that IPO valuation
factors in a potential best-case scenario leaving little room for
disappointments. We note that its valuation and potential store
economics are highly sensitive to assumptions on sales volume and/or
revenues. We present to you alternate scenarios and valuation
sensitivity so you can take your pick. We are unable to view/value Luckin
as a technology company, yet. We had discussed our views on Luckin's
business model and analysed its value proposition in our earlier report
Luckin Coffee: Looking at the Good, the Bad, the Unsure, and the Future ).
D E TA I L
Corrigenda: There are errors in the insight below. Please note the
corrections.
Correction: There are calculation errors in the two charts in the
insight below. The correct charts are as in this box.
Devi Subhakesan 66
Valuing Single Store - Economics of Possible vs Plausible scenarios

for Luckin Coffee compared with Starbucks China ops
Source: Company data, Investory estimates

If you think Luckin's pick up stores can eventually sell 250-300
cups/day with no freebies, in a year or two, then there is an
investment case to consider.
These changes to the numbers also mean changes to the text in

the insight, as here:
• Main body, blue box, paragraph 2: "Best case

scenario (similar volumes as Starbucks Corp (SBUX
US) China) yields..."
• 3rd paragraph (before first chart): "Our conservative

scenario assumes 200 cups/day with no freebies (vs 198
cups/day in 1Q at high discounts, realized revenue of Rmb9.2/
unit only) and for the blue sky, we assume 300 cups/
day (similar levels as Starbucks, China)..."
• Title before second chart: "If you think Luckin's pick up

stores can eventually sell 250-300 cups/day with no
freebies, in a year or two, then there is an investment case
to consider."
• Summary (last paragraph): "if it's volume per store/day can

hit similar level as Starbucks in China (estimate)."
Devi Subhakesan 67
Quick summary. At the proposed IPO price range, Luckin's low

moat mid-tier neighbourhood coffee chain business model needs to
deliver a perfect score on execution/sales volume/weed out
freebies, to be considered for investment; with little room left to
cover the downside - be it from poor coffee demand growth or
competition. Optimistic investors may consider an investment
case based on an estimated best scenario (See analysis below) with
little room left for covering the risk involved in an early stage
venture. For those with better conviction/visibility, there can
be potential upsides from product cross-sell, customer data. We
have limited visibility on these, yet.
For an early-stage venture in a market which is still testing out
coffee, we think, the chances to err on assumption upside/
downside is very high; especially given Luckin's high-cost tech-
like-strategy of subsidising early users to build a dominant segment
position. Unlike technology ventures, a mid-tier pick-up coffee chain
has low entry barriers and limited pricing power. Hence, Luckin's
valuations are highly sensitive to assumptions on future sales
volume potential with lower discounts. At conservative
assumptions, yields are too low to justify investing. Best case
scenario (2/3rd est. volumes as Starbucks Corp (SBUX US)
China) yields attractive margins (albeit at lower revenue) and
suggests an investment case for the optimist. Please take your
pick. See Valuation comparison across different scenario
assumptions below.
Valuation range - Conservative vs

Blue sky scenario - Choice is yours
We present below a valuation comparison based on our estimated single

store economics for Luckin on a future steady state basis - with
negligible discounts, no free deliveries and only reasonable marketing
spend. Although we see little room for Luckin to increase their listed retail
prices from current levels (starting at Rmb21 for brewed beverages) its net
revenue per unit improvement from current levels is projected based on
assumed lower discounts. Hence, the key assumption on future steady
operating phase will be sales volumes per day per store. With no
freebies or free deliveries, how far can it grow? It will be a function of how
strong coffee demand is going to be and the competitive scenario. Our
conservative scenario assumes 100 cups/day (vs 83 presently) and for the
blue sky, we assume 200 cups/day - leading to very different store
economics, returns and valuations. Please take your pick. Both the coffee
market and the company are in the early stage of growth - room to err on
assumption upside/downside is high.
Devi Subhakesan 68
Valuing Single Store - Economics of Possible vs Plausible scenarios for

Luckin Coffee compared with Starbucks China ops
Source: Company data, Investory estimates
Average store investment for Luckin is estimated based on the value of its
equipment and leasehold fittings, discounts offered, subsidy on delivery and
70% of advertisement & promotional expenses (assuming the rest is spent
on the brand building). Data for Starbucks China is from company
presentations.
If you think Luckin's pick up stores

can eventually sell 175-200 cups/
day with no freebies, in a year or
two, then there is an investment
case to consider.
Summary: Luckin's valuations seem heavily hinged on its ability to

drive volumes and cut down discounts/freebies as it evolves towards
a steady state. There is no investment case if you expect a
conservative volume growth. However, at higher sales volume (and
Devi Subhakesan 69
little discount) assumptions, it is worth considering for those

with high conviction and maybe, visibility on digital/cross-sell
upsides.
Although Luckin is mostly a pickup store and not operationally
comparable with Starbucks, it can achieve similar payback on
its store investments, if it's volume per store/day can hit 2/3rd
Starbucks average China levels (estimate). Valuation potential
and upside hinges on if and how fast it can do so. Unless of
course, you are factoring in any digital upside. Potential to
profitably cross-sell other snacks/food and emerge into a QSR too
exists; little visibility yet.
Why we cannot view Luckin as a

Technology company?
Despite media insinuations and management comments towards the

same, we fail to buy into the argument that Luckin is a tech company
and hence need to be valued accordingly.
1. App interface does not make a Tech investment case of - subsidise

early users, achieve a dominant market position, ramp up prices to be
profitable - for a coffee business. While Luckin is following the strategy of
subsidising early users to build a dominant position, it has a low-moat
business with limited pricing power. Luckin can at best cut down on
discounts but has no scope for increasing the price (See images below, it is
priced between Starbucks & Convenience coffee). Our steady-state model
assumes Luckin is able to cut down discounts eventually, and improves net
realisation per unit, without impacting volumes.
2. (Big) Data is the new Oil, just be sure it is not snake oil. Luckin's senior
management has referred to its operations as Data coffee, suggestive of the
potential upside of having access to customer data thanks to its app-based
interface. But we note that its Monthly average (transacting) user base has
remained stable at 4.4 mn across December & March quarters, even as the
cumulative number of transacting customers since inception was 16.8 mn.
With little insight on how Luckin can generate additional revenue from this
customer base, it is difficult to assign significant value to these. The
conventional Coffee chain model is a low risk, high cash flow business, but
Luckin's high growth, the high-upfront cost model is high risk too.
Annexure:
Mid-level pricing and positioning: Luckin Coffee is priced at 2/3rd the

price of Starbucks and 1/3rd above the price of a convenience store coffee
Devi Subhakesan 70
Order receipt at Luckin Coffee vs

Starbucks - different price/value
positioning
Convenience stores in China sell packed coffee at about Rmb15 (vs

Luckin starting at Rmb21)
Devi Subhakesan 71

Thank you. Hope you found the report helpful in your investment analysis. Will highly appreciate if you click Appreciate! We primarily
write about Asia consumer sector related stocks/investment themes with special focus on emerging trends, disruptions and new ideas.
— Devi Subhakesan (02 May 2019)
Devi Subhakesan 72
Luckin Coffee (瑞幸咖啡) - The Art of Burning Cash for Market Share

啡) - The Art of Burning
Cash for Market Share
Zhen Zhou, Toh

We've already covered most aspects of the company and our thoughts on
valuation in:
to Go

Expensive Company
• Luckin Coffee (瑞幸咖啡) IPO Review - Marketed Valuation Is Closer to

Our Blue-Sky Scenario
In this insight, we look into the founder and management team's track
record of taking companies from zero to IPO and how these companies have
performed.
D E TA I L
Luckin's management team mostly

from CAR/UCAR Inc
As per the prospectus, the management team of Luckin Coffee (LK

US) comprised of people (including Jenny) who had previously held
executive positions in UCAR Inc or CAR Inc (699 HK) shown in the table
below. Hence, most people would be asking how is CAR Inc or UCAR Inc
related to Luckin and what do these businesses have in common.
Zhen Zhou, Toh 73

Name Position in Luckin Previous position in CAR/UCAR Inc
Charles Zhengyao Lu Chairman

• Founder/Chairman/CEO of CAR Inc, Chairman
• CEO of UCAR Inc
Jenny Zhiya Qian CEO and Director

• COO of UCAR Inc, executive VP
• COO of CAR Inc.
Jian Liu COO and Director

• Head of yield management of UCAR Inc
• Deputy head of vehicle management of CAR Inc
• Head of yield management of CAR Inc
Dr. Jinyi Guo SVP and Director

• Assistant to Chairman in UCAR Inc
The art of burning money - Luckin's

uncanny similarities with UCAR and
CAR Inc
The common denominator in the three companies is Charles Zhengyao Lu

("Charles Lu") (陆正耀) who was the founder of CAR Inc.
Brief history of CAR Inc

Car Inc is a car rental and used car sales company founded in 2017 and was
able to quickly gain a a strong presence in China, eventually becoming the
largest car rental business based on fleet size, revenue, and network
coverage.
As per media reports, CAR Inc's expansion in China had not been smooth
sailing right from the get-go. In the early days (it was during the 2007/8
financial crisis), Charles Lu lamented that he did not have enough capital for
expansion. But in 2010, he managed to secure an RMB207m investment from
Legend Holdings as per CAR Inc's IPO prospectus. With that capital, Charles
Lu started to expand its fleet and introduced aggressive price war.
In 2012, the company filed for an IPO in the U.S. under the name of China
Auto Rental Holdings but it eventually pulled its IPO citing market turmoil.
Interestingly, as per the old IPO prospectus, the company laid out its
discount strategy.
Zhen Zhou, Toh 74

“ Our average daily rental rate decreased from RMB327 in 2009 to

RMB204 in 2010 and to RMB197 (US$31) in 2011. These decreases
were primarily due to our pricing strategies, including offering
discounts to acquire new customers and enhance customer loyalty at
the early development stage of China's car rental industry. We believe
our efficient cost structure allows us to deliver high quality services to
our customers at competitive prices, thereby retaining and growing our
customer base and enhancing our market leading position.
Shortly after pulling its IPO, Warburg Pincus invested a total of US$200m in
CAR Inc in the same year. Right after the investment, the company wagered
another price war against competitors. According to media reports, there
had been 30 - 50% discounts given during the price war which largely
cemented Charles Lu's reputation as a "Car Rental Madman" (租车狂人).
Just to give a sense of how fast the company had grown since it was founded
in 2007. The rental fleet size of CAR Inc was less than 700, and by the end of
2011, it had reached 25,845 and further doubled to 52,498 as of June 2014,
based on its then IPO prospectus.
CAR Inc officially listed on Hong Kong Exchange as of 2014. Warburg Pincus
has since pared down its stake in CAR Inc to about 15%.
Brief history of UCAR Inc

After the listing of CAR Inc, Charles Lu turned his attention to UCAR Inc
which is a professional ride-hailing service provider. Unlike Didi and Uber,
UCAR's business model relied on their own pool of drivers and car fleet.
UCAR officially launched in 2015 when car-sharing giants like Didi and Uber
were already operating in China. Even after Didi had just completed its
Series D in December 2014, Charles Lu was unfazed by competition. It
secured Series A funding from Warburg Pincus, Legend Holdings and just
Zhen Zhou, Toh 75

two months later, secured another Series B funding. Thereafter, the

company has had another round of financing in January 2016 with strategic
investors like Yunfeng and CICC.
The several rounds of financing gave UCAR the firepower and confidence to
go on a price war and rapid expansion similar to what CAR Inc had done in
the rental car market back in 2012. UCAR Iinc filed for an IPO on China's
NEEQ in the same year (2016) and was finally listed on the 21st of July 2016
just over a year after it was founded.
As per an article on SCMP, at the point of listing, there had been concerns
about the company's cash burn as mentioned by Ray Zhao, an analyst with
Guotai Junan Securities.
“ Ucar must be very very cash-strapped after the cutthroat competition

with its rival Didi Chuxing and Uber. They may have run out of money,
or at least, listing on the Third Board will make its financial position
easier and cheaper, which is vital to survive.
Back to Luckin
Fast forward to today, even though Jenny Qian is listed as the founder of
Luckin, Charles Lu still plays a big part in helping to run the company.
In fact, Jenny Qian and Charles Lu have a long history of working together.
According media interviews, she traveled to Beijing in 2004 and worked for
Charles when he was still a communications officer. Thereafter, when
Charles founded CAR Inc in 2007, Jenny continued to work for him. Jenny
was the COO of UCAR in October 2017 before she left to start Luckin and had
his blessings when she left UCAR.
Furthermore, in an interview as per media reports, she had mentioned

clearly that Charles Lu is the one with the strategies and helps capital
raising/allocation while she is focused on the business and operations.
Also, noteworthy is that some investors in Luckin had invested in UCAR and
CAR Inc before. This included Joy Capital which is led by Erhai Liu who was
previously at Legend Capital (Lenovo) and Centurium Capital.
The histories of UCAR and CAR mentioned above were very brief but
they highlighted the aggressive expansion and discount pricing
strategies which were similar to what Luckin is doing now despite
operating in vastly different industries and the common
denominator is Charles Lu.
Furthermore, UCAR, as of FY2018, has already turned profitable
compared to its net loss of RMB301m while CAR has achieved
profitability and positive FCF since 2014.
Zhen Zhou, Toh 76

Connecting the dots, it is not difficult to see why there had been
numerous reputable institutional investors willing to invest in
Luckin despite its short history. If there is any man who has proven
that he can burn cash for expansion and eventually build a
sustainable business, it would be Charles Lu.
IPO performance of companies

founded by Charles Lu - Pop and
fizzle
With that said, in terms of share price performances, CAR and UCAR Inc had
both traded well on their debut but have struggled to stay above its IPO price
in the longer term. CAR Inc priced its IPO at HK$8.50 per share, the top of
its price range, and traded 28% higher on the first day and popped even
higher in 2015. But, thereafter, it has been all downhill.
As for UCAR, as per the weekly share price chart below, the share price
traded much higher on the first two weeks before tumbling down ever since.
Zhen Zhou, Toh 77

We think that, in Luckin's case, the likelihood that it trades in a

similar manner is high. As like what we have mentioned in our
insights before, if executed well, Luckin could potentially dominate
China's coffee industry.
But, based on our forecast, we think that the guided valuation
assumes that Luckin will operate close to our blue sky scenario. That
would imply that Luckin can achieve both strong ASP and volume
growth in the next two years. We think that it will be difficult for
Luckin to do so mainly because when discounts taper off, we will
likely see slow down or muted volume growth.

Zhen Zhou, Toh 78

Luckin Coffee: Top Line Growth May Not Be Enough to Generate Positive Operating Margins
Luckin Coffee: Top Line

Growth May Not Be
Enough to Generate
Oshadhi Kumarasiri
Positive Operating
Equity Analyst
Margins
By Oshadhi Kumarasiri | 15 May 2019
In our previous insight on Luckin Coffee IPO, Spilling the Coffee: Rapid
Expansion Without Much Due Diligence Could End in Disaster, our analysis
was more based on high level factors such as industry trends, success or
failure of Luckin Coffee’s business model and the competition. With this
insight, we focus more on the ground level factors of Luckin Coffee and try
to forecast its revenue and operating profit under different scenarios. We will
also look at Luckin’s capex requirement for the expansion plan and available
financial resources to meet capex and operating cash requirements.
Furthermore, in this insight, we will also look at Luckin’s same store level
performance and its future growth prospects post this rapid expansion
phase.
• Rapid Revenue Growth through Increased Volume and Pricing
• Cost Reductions Not Enough to Generate Positive Margins Over the

Next 3 Years
• Growth to Halt Post Rapid Store Openings Phase
• Luckin May Get Enough Money to Reach the Target Store Openings,
But They May Not Have Enough to Keep Them Running for Long
• Lock-Up Expires in 180 Days from the Release of the Prospectus: Initial
Investors May Decide to Cash In
• Valuation
D E TA I L
Rapid Top Line Growth Over the Next 3 Years Mainly Coming from
Store Count Expansion
We expect Luckin Coffee’s revenues to grow at a CAGR of about 102% over

2018-21. This top line growth is a direct result of Luckin’s store count
expansion as the company expects to add about 2,400 new stores in 2019
alone, while displacing Starbucks as China’s biggest coffee chain by the
number of stores. We expect this store addition to continue at a significantly
slower rate during 2020 and 2021.
Average Monthly Transacting Customers to Grow at 70% CAGR over

2018-21
Transacting customer growth is highly correlated with the average price per
cup, free product promotional expenditure and mostly the number of stores.
Using linear regression, we forecasted cumulative transacting customers and
monthly average transaction customers.
Source: Company Disclosure & LSR
Despite a Recent Decline, We Expect Per Customer Consumption to

Increase Over Time
As mentioned in our previous insight, Coffee consumption in China is on the

rise. Chinese people have been increasing their per capita coffee
consumption over the last few years and we expect that trend to continue
even beyond our forecast period. As a result, we expect per capita
consumption among Luckin Coffee’s customers to reach 4.0 cups a month by
4Q2021 from the current level of 3.0 cups a month.
As a result of the growth in customer count and the consumption per

customer, average monthly cups sold should increase at a CAGR of more
than 81% over 2018-2021.
Our Base Case Assumes Pricing Will Contribute to the Remaining

Revenue Growth
We expect the average price per cup to reach RMB15.2 by 4Q2021 from the
current level of RMB11.00 per cup. We believe RMB15.2 to be a realistic price
per cup target for Luckin Coffee as it still leaves the company enough
headroom to continue their discounts to remain competitive with Starbucks
and the rest of the competition. The discounts for our base case price
assumptions are at a lower level than what the company has been
maintaining before. However, we expect the level of discounts at our base
case price assumptions to be much more of a realistic target for Luckin
Coffee as we feel it is next to impossible for the company to totally remove
discounts.
Source: Company Disclosures & LSR
Profitability Difficult to Come by Without Significant Improvements in

Average Price Per Cup
Our base case assumptions, forecast Luckin’s gross loss to reduce over time.
However, even after the improvements, we expect the gross margin to
remain negative in 4Q2021.
Raw material costs are expected to increase as Arabica Coffee prices are
currently near the bottom of their range while milk prices are also hovering
near their five year low price. Futures contracts for both milk and arabica
coffee indicates that the prices are likely to increase towards the end of 2019
till mid-2020 and after which the prices are expected to stabilize.
Historical Milk Prices
Source: Cap IQ
Historical Arabica Coffee Prices
Source: Cap IQ
According to our analysis of Luckin’s financials, we believe about 70%-75%

of raw material costs are related to milk and Arabica coffee. Thus, we believe
the expected increase in milk and Arabica coffee prices to significantly cut
down Luckin’s gross margin recovery over the next few years, in spite of
expected price hikes.
Cost Per Cup of Coffee to Increase During 2019 Before its Gradual Fall
Due to Economies of Scale
We have used linear regression to forecast the cost per cup of coffee using
milk & Arabica coffee prices and sales volume as variables and we forecast
the cost per cup to increase in 2019 before the impact of increasing volume
starts to gradually reduce the cost
Store Rental and Other Operating Costs: We Don’t See Enough Room
for Improvement
On the other hand, store rental and other operating costs have very little
headroom to improve. Luckin currently pays an annual rent of about RMB
180,000 per store, since inception it has gradually increased and given
Luckin’s business model we believe its highly unlikely that the company can
reduce the rent per store.
On the other hand, payroll expenses for Luckin’s restaurant staff have been
cut down drastically during the last quarter. Payroll cost per store has
decreased from RMB 110,000 a quarter to RMB 72,000 a quarter. Thus, we
feel it is highly unlikely that Luckin can further reduce payroll costs to have
any significant gross margin gain.
Signs that Luckin Coffee is Running into Troubles?
Advertising expenditure and freebies that Luckin offered its customers faced
a sharp decline in 1Q2019. It’s a bit strange to see a company in its very early
stages of the growth opting to reduce costs from these expense categories, as
these expenses are the ones that ultimately facilitate the company’s growth.
However, Luckin has cut down those costs. Furthermore, despite being very
aggressive on store openings from its inception, 1Q2019 net new store
additions show a significant decline compared to the previous 3 quarters,
which makes us wonder whether the company may be running into cash flow
difficulties.
Delivery Cost: Measures Taken to Reduce the Loss on Delivery
Luckin Coffee generally charges RMB 6.0 per delivery for orders below RMB
35.0, but recently they increased the free delivery threshold to RMB 55.0 to
reduce the loss incurred on delivery. As a result, there is an improvement in
delivery services performance, However, it is important to consider the
impact of increased free delivery threshold towards the sales volume.
Delivery is vital for the company as their business model relies heavily on
delivery and take away orders. As per our calculations, paid delivery alone
amounts to about 14% of the total cups of coffee sold, with free deliveries
accounting for about another 14%.
Luckin Coffee’s Growth May Halt Post Rapid Store Count Expansion
We believe the rapid store count growth to be unsustainable over medium

term and expect the annual new store additions to drastically reduce from
2020 onwards. After which we feel Luckin’s growth will stall as there are
indications that Luckin is struggling on same store performance.
Customer Retention and The Transaction Value Per Customer Shows A

Declining Trend with Time
Luckin Coffee has a higher retention rate during the first few months of
customer, but it gradually reduces over time. This is an indication that
Luckin may find it difficult to retain the customers that they attract through
advertising and other customer acquisition spending.
There is a similar trend in terms of monthly transaction value per customer

as the value of orders are higher during the first few months as a customer of
Luckin Coffee, but it gradually decreases over time.
On the other hand, both the transaction value and the retention rate among
newer customers are relatively lower compared to the retention rate and the
transaction value of older customers during their first few months as a
Luckin Coffee customer. This also indicates trouble for Luckin Coffee as the
new customers are going to be less loyal than the previous ones. We would
note that the steep rises towards the ends of these curves are due to small
sample sizes and upward bias at the very beginning of customers’
transaction histories.
Luckin Coffee’s Dependency on Discounts
Luckin has given deep discounts to attract and retain customers over the
years. However, we feel maintaining similar levels of discounts in future is
not possible due to financial limitations. But the biggest problem is that
Luckin may lose out on its existing and new customers if they do not
maintain the discounts as customers seem to be attracted to Luckin almost
solely because of the discounts.
The following charts show Luckin’s dependency on discounts towards

customer retention and increasing monthly transaction value per customer.
For How Long Can Luckin Coffee Make Losses?
The company has been very aggressive with their store openings ever since
their inception in late 2017. It plans to add about 2,400 stores in 2019, and
we believe this expansion would use up just over $100m of the IPO proceeds
leaving the company with about $400m to finance their operating losses.
Opening up a new store is a relatively easy thing for Luckin, as they only
need about RMB 300,000 excluding the rental deposit to open up a new
store. These stores have very little working capital requirements as most of
the inventory are perishables and also have lower accounts receivables due
to the cash nature of the business. Although it is cheap to open a new store
it is not cheap to run it. Luckin operates at a gross loss. Therefore, each store
would require more than their initial investment to keep the business
running.
Using our base case assumptions, we forecast Luckin Coffee to run out of
cash (including the IPO and private placement proceeds) by 4Q2020
prompting them to look for debt or equity financing sources.
We also feel that the lack of assets to keep as collateral could hinder Luckin’s
ability to pursue debt financing as they have already used up most of the
assets as collateral or they are purchased under capital leases.
Breakeven Price Per Cup
We have analysed Luckin Coffee under two scenarios, first is our base case
where we expect the average price per cup of coffee including VAT to
increase up to RMB 15.0 by 4Q2021, we believe the assumptions are quiet
reasonable as RMB 15.0 per cup would give enough headroom for Luckin
Coffee to maintain their discounts and remain attractive with customers.
However, at RMB 15.0 a cup of coffee we don’t expect the company to
generate any profits even at the end of our forecast period which is 4Q2021.
On the other hand, our bull case assumes an average price per cup of RMB
21.0 by 4Q2021, at which point the company could be generating 11% EBIT
margin. However, we feel it is highly unlikely that Luckin will be able to
completely eliminate the discounts and still remain competitive. According
to our analysis, Luckin will breakeven at an average price of RMB 18.5.
Lock Up Expires in 180 Days
Lock up period ends after 180 days from the release of the prospectus. We
feel that if the share price remains close to the IPO price range until lock up
expiry, initial investors will be inclined to cash in on their investment,
especially given that they could generate more than 300% return as the
average investment per ADS for existing shareholders is just $3.84 per ADS.
Valuation
The lower end of the IPO price range would give Luckin Coffee an EV of
around $2.9bn while at the higher end of the price range with overallotment
option utilized would give the company an EV of around $3.5bn.
Source: Company Disclosures, LSR & Cap IQ
Although the 3 year forward EV/Sales under base case assumptions seems
reasonable compared to Starbucks, it’s a huge risk to bet on Luckin Coffee’s
survival for the next 3 years. And it is also unlikely that Luckin will generate
positive cash flows during the next 3 years. Assuming that they survive the
odds, we still believe Luckin Coffee may not be as profitable as Starbucks
China for at least the next 10-15 years due to the fundamental differences in
the business models. Furthermore, our latest deep dive into the company’s
ground level factors made us even more sceptical about their business
model. Therefore, we feel the risk is too high with Luckin Coffee, especially
when there’s a much safer investment option into the Chinese coffee boom
by way of Starbucks. We would not subscribe.

— Oshadhi Kumarasiri (15 May 2019)
Luckin Coffee (瑞幸咖啡) IPO Trading Strategies

啡) IPO Trading
Strategies
Zhen Zhou, Toh

Luckin Coffee (LK US)'s IPO was priced at US$17 per ADS, the top of its price
range and was further upsized to 33m ADS compared to 30m previously. We
have covered the IPO extensively in:
to Go

Expensive Company

• Luckin Coffee (瑞幸咖啡) - The Art of Burning Cash for Market Share
In this insight, we update our valuation to account for the upsize in offering
and look at past ADR IPO examples to get a sense of how Luckin may trade
tonight.
D E TA I L
Updated base case valuation
Luckin Coffee (LK US)'s IPO was upsized by 3m ADS and priced at US$17 per
share. We updated the our valuation accordingly. Peer multiples have fallen
slightly which dragged down the multiple to 2.44x from 2.53x as mentioned
in our previous insight, Luckin Coffee (瑞幸咖啡) IPO Review - Marketed
Valuation Is Closer to Our Blue-Sky Scenario. We calculate our fair value
for Luckin to be at US$14.06 per ADS which implies a 17% potential
downside.
Zhen Zhou, Toh 91

Scenarios Base
Revenue 6,585
FY2020E EV/Rev Multiple (x) 2.44
Fair value per ADS (USD) 14.06
Implied downside (%) -17%
Sentiment has been good, books

well-covered
However, throughout the bookbuild, we heard that there were strong

interest in the company and the books were well-covered, as per media
reports. Therefore, it is very likely that the market will value the company
closer to its blue-sky valuation/potential no matter how unrealistic it might
be. The recent mad rush in Beyond Meat Inc (BYND US) is a case in point.
Using the same valuation methodology and our blue-sky assumptions,

we calculate our blue-sky valuation of Luckin to be at US$26.11 per
ADR which implies a 54% potential upside.
Scenarios Blue sky scenario
Revenue 14,351
FY2020E EV/Rev Multiple (x) 2.44
Implied upside (%) 54%
For reference, the table below is the blue-sky assumptions that we have
used. We have extended the blue-sky assumption to FY2020E and adjusted
ASP to hit RMB16 per drink in line with what management has repeatedly
mentioned during their IPO roadshow.
Zhen Zhou, Toh 92

No. of stores 2,370 4,870 5,870
How we would trade this
We compiled a handful of US ADR that we think were high-anticipated at the

time of their IPO launch, namely HUYA Inc (HUYA US), iQIYI Inc (IQ US),
Pinduoduo (PDD US), Tencent Music (TME US), and NIO Inc (NIO US) and
plotted their first 30 days share price performance.We think that
Luckin could trade in the same manner. With the exception of Huya, most
other larger IPOs popped in the first week and traded down from their
first week high.
Considering its expensive valuation (base-case), we think that after the first
week, the market will adopt a wait-and-see approach until the next quarter
announcement to see whether management can deliver the growth that they
have promised; mainly in cutting discounts and raising the average ASP of
drinks.
After all, in its historical data, the company has yet to demonstrate
convincingly that it can grow its average daily number of customers per
store and ASP of drinks which is likely distorted by the growth of its new
stores. Hence, it would probably be good for investors to take profit within
the first week if and when it materializes.
Zhen Zhou, Toh 93

The price performance of other IPOs in the past six months have mostly
traded in the same manner. Most IPOs would typically trade higher in the
first week and retrace down subsequently. Whereas only a handful such as
So-Young (SY US), Futu Holdings Ltd (FHL US), and Up Fintech (TIGR
US) stayed at those elevated levels.
For investors who are looking at the longer investment horizon, we would
wait to be buyers between US$13 - 14 per ADS which is a small discount to
our fair value of Luckin based on base-case assumptions shown in the
sensitivity table below.
FY2020E EV/Revenue
Price Base case Blue-sky
13 2.29 1.05
14 2.54 1.17
15 2.79 1.28
16 3.04 1.39
17 3.28 1.51
18 3.53 1.62
19 3.78 1.73
20 4.02 1.85
21 4.27 1.96
22 4.52 2.07
23 4.76 2.19
24 5.01 2.30
25 5.26 2.41
Zhen Zhou, Toh 94


Zhen Zhou, Toh 95

Luckin Coffee's Upsized IPO: Why Investors Trod Where Analysts Feared?
Luckin Coffee's Upsized

IPO: Why Investors Trod
Where Analysts Feared?
Devi Subhakesan
By Devi Subhakesan | 20 May 2019
Asia Consumer Research

Luckin Coffee (LK US)'s upsized IPO listed at Nasdaq last week with an
attractive debut-pop at USD25 vs IPO price of USD17 and eventually closed
at USD20.38 after trading 38 mn shares. The issue that raised USD561 mn
from 33 mn ADS was earlier oversubscribed 20X. Investors seem to be
wanting more of the neighbourhood pick-up coffee chain with an audacious
startup model for a low moat business. Or, were some of them looking to
cash out after earning a quick return?
Many investors seem to have taken a different view of this very

different company versus analysts on this platform. While we
were upbeat about Luckin's business proposition, we were cautious on
valuations. Our analysis of Luckin's business model - Luckin Coffee: Looking
at the Good, the Bad, the Unsure, and the Future left us with an optimistic
outlook. However, the asking price didn't seem to leave enough to cover the
risks of a startup venture as we wrote in our report Luckin Coffee IPO: Best
Latte Scenario Priced In Unless You See Data Coffee. In the note below, we
look at what our cautious analysis didn't factor in, and what may have
infused confidence in investors to back a conventional business (coffee
chain) startup with an unconventional (tech like) model. Also, we look
at what investors can look forward to in terms of news flows to validate
their investment premise.
D E TA I L
Investors saw the glass half full,

Analysts saw the glass half empty
Quick summary. Our retrospective analysis post-Luckin's attractive
stock market debut leads us to believe that IPO investor enthusiasm
was probably backed by the big picture opportunity of a fast-growing
brand (Luckin) in an early stage segment (coffee chains in a predominantly
tea country) in a market with immense possibilities (youngsters in China)
Devi Subhakesan 96
that had promoters with a successful track record as well as institutional

investor backing. While we were enthused by these positives, it seemed
difficult to justify a convincing investment case at the issue price for a
conventional low moat business at its early phase of operations where there
is little visibility on sustainable operating metrics.
What Investors looked at that Analyst

worksheets didn't factor in!
• Investors looked at Startup vision, Analysts worried about
sustainable revenues & margins
With only one year's financials made available for analysis thanks to
Luckin qualifying as a startup under Nasdaq (and it's short operating
history), it offered limited visibility on how its sustainable business
model could eventually look like. Our analysis did not factor in any
potential upside from non-coffee revenues nor did we have clarity on
how Luckin could potentially encash its customer data. Management in
earlier interviews talks about data coffee, referring to possible digital
upsides. Investors with better insight into the Management's vision on
these as well as potential operating metrics would have had a stronger
conviction to invest.
• Investors saw promoters with a proven track record, Analysts saw

discounted coffee
Luckin's promoters/core management team (including Chairman

Charles Zhengyao Lu and CEO Jenny Qian Zhiya) have a successful
startup track record behind them - its the same team that launched
and listed UCar Inc (NEEQ: 838006, first on-demand chauffeured car
services stock to be listed in China) and counts Warburg Pincus and
Alibaba Group Holding (BABA US) amongst its investors. It also
spawned Car Inc (699 HK), a leading car rental company.Luckin also has
reputed institutional investors backing it - funding its aggressive
growth model and cash burn over the year. Fresh IPO investors would
have found these comforting factors while deciding on the investment.
As for financial analysts, Luckin's audacious store/revenue growth in a
year was led by deep discounts on coffee/food/delivery. It's business
model doesn't target an exclusive opportunity, nor have an inimitable
value offering to customers. It is just discounted coffee, for now.
• Investors saw Disruption, Digital & Delivery, Analysts saw high

cash burn
Luckin's unconventional operating model (subsidise early users, the

pursuit of market dominance, technology interface and home-delivery)
for a conventional business (neighbourhood pick up coffee store) don't
fit in well in traditional analyst models that look out for free cash.
Unsurprisingly, analysts were alarmed by Luckin's high cash burn rate
(discount coffee, free offers on drinks n food, free delivery) while
Devi Subhakesan 97
leading institutional investors kept funding it. Unless Luckin's older

stores turn free cash positive this year, it runs the risk of running
out of cash by year end (See cash estimation below).
What can IPO proceeds of USD561 mn mean for Luckin? It would be

sufficient to fund Luckin's announced expansion plans for another
year, expected at the rate of 200 to 300 stores a month and also
support the present rate of promotions/subsidy led cash burn of
around USD100 mn per quarter. Assuming that existing stores
gradually begin to mature to generate positive margins and the cash
burn is limited to the newer stores only, Luckin should be able to
maintain its near term operating cash losses at 1Q2019 levels of less
than USD100 mn per quarter. Management must be anticipating that by
the end of the year it would be able to fund future growth and
promotional expenses from cash generated by older/maturing stores.
Luckin Coffee (LK US) - Tracking your

investment: News flow/events to look
forward to :
“I don’t have a timeline for profit,” Jenny Qian Zhiya, the CEO and founder
of Luckin Coffee, reportedly told Reuters few months ago “For us, what we
care about now is the number of users and if they are coming back to us,
whether they recognise us, whether we can take market share.”
Luckin could potentially start reporting Same Store Growth (SSG) data
from June or September quarter results. It had 624 stores and 1189 stores as
of last year June 30th and September 30th, respectively. If they report
improved operating metrics and/or lower cash losses for these stores than
was reported for the firm for 1Q2019, it will be a positive - both
sentimentally and for cash flow visibility.
New store addition and average monthly transacting customer data:

Management has stated plans to add 200 to 300 stores per month (vs 300
stores it added in 1Q2019, probably due to a shortage of funds). With IPO
funds available, expect the company to deliver on its ambitious target. If it
manages to amply ramp up it's average monthly transacting customers
(nearly stagnant across 4Q 2018 and 1Q 2019 quarters despite 300+ stores
added) at current/higher revenue per unit, it will be viewed positively.
Data coffee Potential - news flow on tie-ups to cross-sell/monetize

customer base. Any initiative towards monetizing its customer data
through cross-selling/utilizing database to widen revenue potential will be
viewed as a positive. Management has remarked how their technology
interface sets them apart from other coffee chains given its potential to
understand buyer behaviour and tailor products/promotions accordingly.
Annexure: Investment analysis view
Devi Subhakesan 98
Quick Recap from our last reportLuckin Coffee IPO: Best Latte Scenario
Priced In Unless You See Data Coffee
Quick summary. At the proposed IPO price range, Luckin's low moat mid-
tier neighbourhood coffee chain business model needs to deliver a perfect
score on execution/sales volume/weed out freebies, to be considered for
investment; with little room left to cover the downside - be it from poor
coffee demand growth or competition.Optimistic investors may consider
an investment case based on an estimated best scenario (See analysis
below) with little room left for covering the risk involved in an early
stage venture. For those with better conviction/visibility, there can
be potential upsides from product cross-sell, customer data. We have
limited visibility on these, yet.
If you think Luckin's pick up stores can eventually sell 250-300 cups/day
with no freebies, in a year or two, then there is an investment case to
consider.
Economics of Possible vs Plausible scenarios for Luckin Coffee compared

with Starbucks China
Devi Subhakesan 99

Thank you. Hope you found the report helpful in your investment analysis. Will highly appreciate if you click Appreciate! We primarily
write about Asia consumer sector related stocks/investment themes with special focus on emerging trends, disruptions and new ideas.
— Devi Subhakesan (17 May 2019)
Devi Subhakesan 100

Luckin Coffee: A Quick Path to Profitability Possible but Unrealistic – Quantamental
Luckin Coffee | Equity Bottom-Up
Luckin Coffee: A Quick

Path to Profitability
Possible but Unrealistic
Oshadhi Kumarasiri
– Quantamental
Equity Analyst
By Oshadhi Kumarasiri | 06 Oct 2019
In our previous insights on Luckin Coffee IPO, we discussed how we felt that
the top-line growth would not be sufficient to generate positive operating
margins in the near future.
• Spilling the Coffee: Rapid Expansion Without Much Due Diligence

Could End in Disaster
• Luckin Coffee: Top Line Growth May Not Be Enough to Generate

Positive Operating Margins
China’s coffee market is experiencing rapid growth, however, when

compared with mature coffee markets it is still at an infant stage. We felt
that Luckin Coffee’s business model was more suited to a mature coffee
market and the aggressive expansion could lead to Luckin Coffee running
out of cash before the Chinese coffee market matures to a point where the
market is capable of accommodating Luckin’s business model.
However, Luckin had an ace up his sleeve, which we were unaware of at that
time. Contrary to its name, Luckin is not just a coffee company now. They
are also a tea company. We were initially skeptical about how Luckin was
managed, as we felt the company’s sole purpose was to surpass Starbucks
China at any cost. Now we feel that they have come out of it, the fact that
they launched tea and they are also open for other ventures made us change
our opinion on Luckin’s management.
We are not utterly convinced that Luckin will be a success over the long term
just yet. But things such as our quantamental analysis and fundamental
equity analysis shows that there could be a path to profitability by 2021.
However, we feel that it would take a few more quarters for us to predict the
direction of Luckin Coffee with a better degree of accuracy. Until then, we
believe it is worthwhile keeping a keen eye out for Luckin Coffee.

D E TA I L
Robust Revenue Growth Through Increased Number of Customers and

Increased Per Customer Spend
The cumulative number of transacting customers increased 35% in 2Q 2019,

driven by 593 net new store openings. Our quantamental analysis shows that
new customers strongly correlate with the store count.
Furthermore, the average price per cup has a negative correlation with the
customer count.
We have used a multifactor regression based on average price and store

count to forecast the number of transacting customers.
Following forecasts are based on a 3% QoQ pricing increase until 2021 to

reach a post VAT average price per cup of RMB 16.1 in 4Q 2021.
Furthermore, we forecast the number of stores to reach 5,400 by 2021.

Based on the above pricing and store count assumptions our linear
regression model forecasts the number of transacting customers to grow at a
62% CAGR over 2018-21.
Conversion to Monthly Transacting Customers Improved Marginally

but Remains Substantially Below the Historical Levels
Luckin Coffee’s customer addition is nothing but excellent. They added

almost 6m new customers during 2Q 2019. However, our concern is about
retaining them and making them regular users. Customer retention
improved marginally in 2Q2019, which could be due to the introduction of
new products such as Luckin Tea. However, what is more concerning is that
at 27% customer retention is still very low compared to 2018 levels.
Similarly, to the total transacting customers, we found out that the monthly
average transacting customers correlate with the total transacting
customers, average price per cup and free product promotion expenses.
A linear regression using those variables forecasts the average monthly

transacting customers to grow at a CAGR of 51% over 2018-21.

Revenue Per Customer Growth Through Average Pricing and Cups Per
Customer
Luckin Coffee’s 2Q 2019 earnings surprise stems from this point as we didn’t
expect a paradigm shift in their business model. The company’s initial
perception as a coffee chain changed within just few months from the IPO as
it started selling tea along with coffee. Furthermore, there are indications
that the company is willing to change even more in the upcoming months
and years. For example, Luckin Coffee is testing the use of vending machines
in areas where the rent is excessively high.
The average price per cup of freshly brewed drinks increased 13.4% QoQ in
2Q 2019. A portion of the pricing growth came from reduced VAT rate as it
declined to 13% in 2Q2019 from 16%. The remaining amount of pricing
growth came mainly through the change in product mix as Luckin Coffee
introduced a new product range called Luckin Tea. Furthermore, the
company also mentions that the average pricing also increased as they
reduced discounts through their dynamic pricing system.
However, our analysis suggests that most of the pricing increase may have
come from reduced VAT and the change in sales mix. The Change in
Transacting Customers Vs Change in Price Per Cup chart (Chart 2) shows an
increase in the net new customer count despite increased pricing, which is
different from the previous quarters. Luckin tea is priced higher than Luckin
Coffee. Furthermore, products other than tea have started to contribute
about 50% of the freshly brewed drinks revenues from 2Q 2019. All these
suggest that there may have been a substantial shift in the revenue mix
possibly creating a favourable average pricing condition.
On the other hand, cups per monthly transacting customer increased 15%
QoQ in 2Q 2019 driven by the introduction of Luckin Tea. Luckin Tea opened
a new market for the company with a relatively low investment. According to
the company, the consumption times of tea and coffee are different and
therefore, the launch of tea helped Luckin to sell its tea to its existing coffee
customers without having a material cannibalisation effect on its coffee
sales.

Revenue Per Cup Vs Cost Per Cup
In RMB 1Q2018 2Q2018 3Q2018 4Q2018 1Q2019 2Q2019
Revenue 8.9 10.1 10.3 8.8 9.8 11.0
Cost of materials 6.4 6.3 6.5 5.6 5.6 5.6
Store rental and other operating costs 13.8 8.3 7.4 5.4 5.8 4.5
Depreciation 2.7 1.2 1.2 1.1 1.7 1.1
Sales and marketing costs 37.2 14.8 9.7 5.4 3.4 4.7
General and admin costs 26.7 6.2 5.1 2.8 3.5 3.2
Store preopening and other costs 7.6 1.8 1.3 0.7 0.5 0.2
Total operating expenses 94.4 38.7 31.2 21.0 20.6 19.3
Operating Loss Per Cup -85.6 -28.6 -20.9 -12.2 -10.8 -8.3
Over the last six quarters, the company managed to make gains on the cost
side mainly through the increased number of cups per customer and store.
Apart from the cost of materials, all other costs on a per cup basis show a
considerable level of correlation with both cups per customer and cups per
store figures. The cost of material per cup has remained relatively stable
since 4Q 2018. Therefore, feel the improvements stemming from cost of
materials will be limited going forward, which is contrary to Luckin Coffee
management’s belief. However, we believe that the other costs have
substantial room for improvement on a per cup basis.
Correlation Cups Per Customer Monthly Cups Per Store
Cost of materials (0.3) (0.6)
Store rental and other operating costs (0.8) (0.9)
Depreciation (0.9) (1.0)
Sales and marketing costs (0.8) (0.9)
General and admin costs (0.9) (1.0)
Store preopening and other costs (0.9) (1.0)
Total operating expenses (0.8) (0.9)
Based on our above analysis we forecasted the per cup profitability of Luckin
Coffee.

Source: Company Disclosure and LSR
It would appear that Luckin Coffee would have to wait until 3Q 2021 to
generate an operating profit even when the company is successful in
increasing the average pricing by 3% QoQ. A 3% QoQ average pricing growth
till 3Q 2021 may be bit optimistic specially given that Luckin Coffee’s
business model is based mainly on discounts.
On a slightly reasonable average pricing growth of 1% QoQ, our model shows

that Luckin Coffee will remain making losses even beyond 2021.
Source: Company Disclosure and LSR
Will the company manage to keep on increasing average prices and maintain
growth as they did in 2Q 2019 or will they fail to do so is still an unknown
and we feel that the share price will remain at the current levels until those
investor concerns are resolved. Hence, we would wait until the dust settles
before changing our stance on Luckin Coffee.


— Oshadhi Kumarasiri (05 Oct 2019)

Luckin Coffee (瑞幸咖啡) Lock-Up Expiry - Short Closer to Q3 as Pre-IPO Investors May Look to Sell

啡) Lock-Up Expiry -
Short Closer to Q3 as
Zhen Zhou, Toh
Pre-IPO Investors May
Look to Sell
By Zhen Zhou, Toh | 11 Oct 2019
Luckin Coffee (LK US)'s lock-up will expire in about a month, on the 13th of
November. We have covered the IPO extensively in:
to Go

Expensive Company

• Luckin Coffee (瑞幸咖啡) - The Art of Burning Cash for Market Share
• Luckin Coffee (瑞幸咖啡) IPO Trading Strategies
In this insight, we will look at how the company has performed since listing
and the potential sellers upon lock-up expiry.
Zhen Zhou, Toh 108

D E TA I L
Updates on Q2 results - performed

better than our base case
Luckin Coffee (LK US) announced its 2Q 2019 results on August 14, 2019.
Results were better than our base case estimates as shown in the table
below. Key takeaways:
• Store expansion was behind our expectations. We were expecting the

company to expand by about 2,500 stores for 2019E and get to 3,203
stores by June 2019 but Luckin was about 7% behind our forecast.
• Average monthly transacting customers were 5% below our

expectations.
• Nonetheless, the company more than made up for the shortfall

through an increase in the volume and revenue of items sold.
Average monthly items sold were 11% higher than our forecast
while the ASP (revenue per item) was up by 15%.
• The company did not breakdown the number of freshly brewed drinks
and other products sold judging by the revenue breakdown we are
guessing that the main source of underestimation came from other
products which Luckin has outperformed out estimates by a good 84%.
• Beyond that, the unit costs of Luckin have improved significantly. As

per the company the operating loss per store has shrunk while cost per
cup has fallen significantly.
Zhen Zhou, Toh 109

• The company has also announced that it had expanded its products into
brewed tea which has an extremely competitive landscape with
established brands such as HeyTea (喜茶), Naiyuki (奈雪の茶), and Lele
Cha (乐乐茶) in China.
Some investors may look to book

gains
Below is the full list of pre-IPO investors, including Louis Dreyfus which
invested in the company via the concurrent placement during the IPO.
• The names highlighted in red are pre-IPO investors whom we could not
find much information on and we think are likely to be sellers.
Specifically, Star Grove Global Limited listed Zhang Yihui as the
director of the firm and we found that he has been the manager of
Luckin as per this link and doesn't seem to be part of the founding nor
has any connections with them.
Zhen Zhou, Toh 110

• Taide Investment is likely to sell because they ended up with a stake

in Luckin as a result of warrants issued in conjunction with the long-
term borrowing agreement it had with Luckin. The warrants entitled
Taide Investment to invest in Luckin at just 1.6x of Series A issuance
price which gives Taide a good 101% investment since its borrowing
agreement in December 2018.
• If we assume that all financial investors like BlackRock, Darsana

Capital, Louis Dreyfus, Joy Capital (Liu Erhai), Centurium Capital, and
GIC, are looking to sell to book their gains upon lock-up expiry, the
implied overhang is about 70m ADS (or about US$1.3bn), which
represents 29% of total shares outstanding and 19 days of three-
month ADV.
• Among these investors, we think that some may not look to sell
out completely, specifically, the two (out of three) financial
investors in Series A, Liu Erhai and Centurium Capital (which is
owned by David Hui Li). These two investors have a strong connection
with Charles Lu because they have had success with investing in
Charles' earlier start-ups, Shenzhou UCAR and CAR Inc.
• They probably have a strong commitment to stay invested in Luckin

beyond lock-up expiry, but returns from their investment cost for a
period of a little over a year ago may look tempting enough for them to
at least monetize a portion of it.
Zhen Zhou, Toh 111

• Aside from the two investors, Louis Dreyfus will probably not be
looking to sell any time soon considering that it has just started their
joint venture with Luckin in China as of 26th September and they had
only invested in the company since the IPO.
• Hence, if we assume Joy Capital (Liu Erhai) and Centurium Capital will
sell, say, 50% of their investment upon lock-up expiry, and Louis
Dreyfus to hold onto their shares, the overhang is still substantial, at
about US$920m but will only take about 13 days for the market to
absorb.
How we think it trades in the near-

term - shorting only when lock-up
expires
We note that the lock-up expiry date uncannily coincided with Luckin's
estimated Q3 results date as per Bloomberg.
Luckin traded well going into its Q2 results (red line) while major indices,
S&P and HSCEI (yellow and green line respectively), were mostly flat over
the same period. Considering the strong Q2 performance, there is good
chance that Luckin can continue to build on this momentum and beat
estimates for the quarter. It would make the case for shorting into the
lock-up expiry less compelling.
Zhen Zhou, Toh 112

Furthermore, it hasn't been uncommon for Chinese ADR listings to rally into
their lock-up expiry. NIO Inc (NIO US) and Qutoutiao Inc (QTT US) are cases
in point (NIO shown in the chart below red line indicates the lock-up expiry
date). Both companies are now trading way below their peak price,
exacerbated by their disappointing results and poor fundamentals.
Estimates are fairly aggressive - Luckin

needs to get a lot of things right
The street has been are fairly bullish on Luckin as seen from the forward
estimates. It sits closer to our bull case scenario and revenue is expected to
almost triple in FY2020E. By our estimates, this means that ASP (revenue
per item) would need to increase by another 50% in FY2020E and store count
Zhen Zhou, Toh 113

to almost double from its Q2 number. As per our earlier IPO notes, this
would imply that the Luckin team needs to execute their expansion
plan perfectly in the next two years to meet these estimates.
Hence, we think that the better trade here is to only short post Q3
results which is right on the day of lock-up expiry in which some
investors may come to the market to monetize their investment.
Conclusion
• Luckin has done well in its Q2 results. It has achieved strong
ASP growth, lowered unit costs of drinks, and shrunk losses per
store. Results were ahead of our base case scenario.
• We note that pre-IPO investors are holding on to returns

ranging between 36% to 212% (Joy Capital and Centurium
Capital) for just over a year of investment (for Series A
investors) which makes a compelling case to monetize a portion
of their investment.
• However, considering that Q3 results is right when lock-up

expires, we think that shorting into lock-up may not be the best
trade. We would be on the short side closer to or on the day
of Q3 results.

— Zhen Zhou, Toh (10 Oct 2019)
Zhen Zhou, Toh 114

Luckin Coffee 3Q19 Quantamental Analysis: Price Hike Unjustified as Marginal Cost Improvements Fade
Luckin Coffee 3Q19

Quantamental Analysis:
Price Hike Unjustified
Oshadhi Kumarasiri
as Marginal Cost
Equity Analyst
Improvements Fade
By Oshadhi Kumarasiri | 14 Nov 2019
th
Luckin Coffee share price opened trading on 13 November 2019, up 15.3%
from the previous close price of $18.98 as the company’s 3Q19 results beat
the revenue guidance and consensus estimates. However, the 3Q19 EBIT was
lower than the consensus estimates.
The store level profitability is a KPI of the company and it is calculated as

follows:
• (net revenues from products - cost of materials - store rental and other
operating costs - depreciation expenses) / net revenues from products
The company guided that it will reach store level breakeven in 3Q19 and the
actual result was better than expected as Luckin Coffee increased the store
level profitability from -6.4% in 2Q19 to 12.5% in 3Q19.
Therefore, the market reacted to this revenue and margin surprise with a
15% increase in the share price.
We believe the revenue surprise was mainly due to better than expected
results from the new products such as Luckin Tea and better than expected
store level profitability was down to increased sale of products other than
freshly brewed drinks.
We think it is more important to focus on the deteriorating marginal gains

than getting hung up on the revenue and store level profitability surprise.
Since the start of 2019, almost all of the margin gains came from the cost of
materials, store rentals and depreciation side, while sales and marketing
costs stabilised in the 35% of revenue range.
Although attractive on the outside, 3Q19 results show a weakening trend in

the marginal store level costs (cost of materials, store rentals and
depreciation) of Luckin Coffee indicating to us that the QoQ incremental

margin gains may soon start to fade. We believe it is not a good sign for any
company, but especially for an aggressive start up like Luckin Coffee as they
are still far from breaking even.
D E TA I L
Store Level Profitability is Not Everything
Store level profitability is an important indicator. However, it does not

include all the operating costs. As shown in the chart below, Luckin’s initial
focus was mainly on gaining operating leverage in costs such as sales and
marketing and admin expenses as the proportion of store level costs
increased until 1Q19. However, lately the focus has shifted to store level
costs as the proportion of store level costs has decreased from 76% to 65%.
Sales and marketing and general and administration expenses have already
stabilised and they have little room to improve. Currently, general and
administration expenses are at about 16% of the revenues and sales and
marketing is about 36%. Based on the marginal costs, the room for
improvements in sales and marketing and general and administration is
limited to about 15% of revenues.

Thus, there is not enough potential on the SG&A side alone to turn Luckin
Coffee profitable anytime soon, Therefore, the potential deterioration in the
store level profitability becomes a major catalyst to downgrade Luckin
Coffee.
Customer Retention
It is a positive that the customer retention has increased for the second
consecutive quarter. The cumulative number of customers increased 35%
QoQ in 3Q19, driven mainly by the new store additions. At the same time,
monthly transacting customers grew more than 50% QoQ indicating an
improved customer retention. We believe this is due to the introduction of
Luckin tea and also the increased sales and marketing spend.
Cost Per Cup of Freshly Brewed Drinks Stabilising

Cost of freshly brewed drinks is the main cost item included in cost of
materials (69% of the total cost of materials). The second quarter 2019 saw
an increase in per cup cost of freshly brewed drinks as gains from operating
leverage and decreased coffee prices were more than offset by increased milk
prices and the impact of the introduction of new products.
In 3Q19, cost per cup remained at the same level as 2Q19, despite increased
coffee and milk prices.
The cost per cup has a strong correlation with the coffee and milk prices as
well as with the sales volume. Using a linear regression, we forecasted cost
per cup figures and so far, we have been able to predict the cost per cup
change with a high degree of accuracy.
Given that the milk prices and coffee prices are expected to increase we
believe it will be difficult for Luckin Coffee to decrease the cost per cup in
the near future.
Cost Per Unit of Other Products Increased 1.4% QoQ
The cost of other products is about 22% of the total material costs and on a
per unit basis costs have followed a declining trend over most of the last
seven quarters. The declining cost per unit of other products was the main
driver behind the recent incremental improvements in Luckin’s overall
material costs. Per unit cost of other products declined 29% QoQ in 2Q19
and as a result, the overall material cost as a percentage of revenue
decreased substantially. However, 3Q19 shows an increase in the per unit
cost of about 1.4%. This increase is a major red flag for us as we feel that the
cost per unit may have bottomed. Besides this, the cost per unit is almost
half it used to be and at RMB 5.4 per unit, there seems to be very little room
for further improvements.

Conclusion
We believe the market reaction to Luckin Coffee’s store level profitability is

unwarranted given that the company still generates a 38% operating loss
margin. In addition, there are signs that the cost side improvements are
fading. Therefore, in future we believe Luckin will have to rely on pricing to
maintain the margin improvement trend.
The average pricing has increased QoQ in three back to back quarters.
However, in 1Q19 the pricing increase had a substantial impact on customer
count growth. The pricing increase afterwards was mainly through the
introduction of new products.
In 3Q19, QoQ pricing growth for both freshly brewed drinks and other
products halved from the 2Q19 level. However, it was still plentiful and
therefore, the company managed to improve margins more than expected
despite the improvements in the cost side lagged behind expectations.
The QoQ pricing increase was mainly due to the introduction of the new
Luckin Tea range. However, we feel the impact of Luckin Tea on price per cup
will soon weigh in completely and once that is done, Luckin is likely to
disappoint the market.


— Oshadhi Kumarasiri (14 Nov 2019)

Luckin Coffee’s Unit Cost Dynamics
Luckin Coffee’s Unit

Cost Dynamics
By Oshadhi Kumarasiri | 25 Nov 2019
Oshadhi Kumarasiri
Equity Analyst
Since the 3Q19 results release, Luckin Coffee’s share price rallied to reach an
all-time high of $29.85. The news of reaching store level operating
profitability was the main catalyst behind this rally. The company also said
that they are just 12 months from reaching consolidated level operating
profitability.
*store level profitability excludes advertising and marketing spend as well as

admin expenses, which together amounts to about 47.5% of revenue.
In this insight, we will analyse Luckin Coffee’s unit cost dynamics to

understand the improvement potential in costs, furthermore, we look at the
current revenue per unit and the revenue per unit growth required to
breakeven.
D E TA I L
Unit Cost Dynamics: Optimistic Bull

Case Points to a 2% EBIT Margin
Through Cost Efficiencies
Luckin Coffee has five main costs in the income statement. Below we analyse
the main ones on a per cup basis to estimate their improvement potential.
• Cost of Raw Materials

Raw material cost per unit/item is one of the main components of the total
cost. It currently represents 32% of per item cost. Per item, raw material cost
was just RMB 3.68 at the end of 1Q18. However, it has gradually increased
with coffee and milk prices. We believe the introduction of Luckin Tea had
minimal impact on per cup raw material cost as Luckin mentioned that the
unit costs are rather similar. However, the introduction of Luckin Juice and
dedicated Luckin Tea stores could change the per unit raw material cost
structure. However, we believe the retail Juice business and the Launch of
dedicated Luckin Tea stores in lower tier Chinese cities could pressure the
already negative EBIT margin.
Raw materials costs are mainly variable and therefore, its highly unlikely
that Luckin will be able to generate meaningful cost savings from increased
sales volumes. Instead, we believe per unit cost will remain stable until 2020
as we forecast the Arabica coffee price to increase while milk prices decline.
• Store Rental and Other Operating Costs

Store rental and other operating costs per unit is about 23% of the total per
item cost. The cost varies mainly with the store count. Therefore, increased
volume per store helps the company to reduce cost per unit.
However, the store rental and other operating costs per unit has already
declined to RMB 3.60 from RMB 13.83 as the number of items sold per day
has increased from 109 units to 444 units. Further improvements in store
rental and other operating costs, depends on the ability to increase the units
per store number beyond the current 444 units a day level.
A Starbucks store in the US generally sells more than 1,000 coffees a day. So
Luckin’s current 444 items a day has the potential to improve. However, the
Chinese and the US markets are at different levels of maturity and therefore
we feel it may take a long time for Luckin to reach that level. Furthermore,
Luckin stores are smaller than Starbucks and therefore would have lower
output. Thus, we expect in the medium term, Luckin’s daily items per store
may reach about 700 items in the best-case scenario.

• Sales and Marketing Costs
Sales and marketing costs are about 27% of the per unit cost and they are
relatively fixed in nature. Sales and marketing cost per item decreased at a
much faster rate until 1Q19 and since then it has increased by about 22%.
We believe the increase is mainly attributable to the launch of Luckin Tea.
The company mentions in their 3Q earnings call, that they will reduce the
sales and marketing costs going forward. However, marketing costs and new
customers have a relatively strong relationship. Therefore, cutting down on
marketing could slow down customer acquisition and eventually revenue
growth.
We looked at all the Asian restaurant chains to understand the industry

average sales and marketing expenditure level. There are certain chains who
spend virtually nothing on sales and marketing. At the same time, there are
companies who spend more than 50% of their revenues on sales and
marketing. On average sales and marketing spend is about 15% of revenue
for the selected 130 Asian restaurants.
Given Luckin’s reliance on sales and marketing spend to attract new

customers, we believe Luckin’s ideal sales and marketing spend level to be
slightly higher than the industry average level.

• D&A Costs
D&A is about 5% of the total cost per item. It correlates with the store count
and therefore has the potential to decline on a per item basis. However,
currently D&A per item is about RMB 0.82 and therefore we expect the room
for substantial improvement to be limited.

Scenario Analysis - Cost Per Item
We believe Luckin Coffee’s path to profitability is dependent on its ability to

reduce discounts and increase per store item volume. Luckin’s current daily
sales per store is about 444 items. We believe that it has the potential to
increase over the long to medium term. However, we expect the current
growth rate to reduce drastically in the upcoming quarters. 30% QoQ growth
of the daily volume per store over the last two quarters was mainly
attributable to the launch of Luckin Tea. We expect the impact of the Luckin
Tea launch to fade from 4Q19 and therefore we expect daily sales volume per
store to remain stable at 444 items a day.
To analyse the long-term margin improvement potential, we have done a

scenario analysis based on three different daily items per store levels. As
there is little room for improvements in the raw material cost side, we have
kept it constant. As discussed above, other costs have been forecasted based
on the main cost drivers. We believe in future, Luckin’s effort will focus on
cutting down marketing expenditure as further improvements on other costs

excluding marketing depends on a substantial increase in the items per store

figure. Therefore, we have assumed that Luckin will reduce the marketing
spend to 17% (2% above the Asian restaurant industry average) of revenues
in future.
Daily Items Per Store @ 444 @ 550 @ 700
Store rental and other operating costs per unit 3.56 2.87 2.26
Raw material cost per unit 4.93 4.93 4.93
Sales and marketing cost per unit 2.40 2.40 2.40
General and admin cost per unit 1.52 1.22 0.96
D&A cost per unit 0.81 0.65 0.51
Item Cost 13.22 12.08 11.07
Per Item Revenue 11.25 11.25 11.25
Profit/Loss Per Item (1.97) (0.83) 0.18
Margin -18% -7% 2%
Profitability Depends on the Ability to Exit the Discount Model
The cost improvements alone are not enough to be profitable. However, the
company has guided that they will breakeven at EBIT level by 3Q2020. In
order to breakeven, Luckin will have to increase the revenue per item by
about 13% from the current level. The company has managed to increase the
revenue per item substantially over the last few quarters. However, we
believe this is partially driven by the launch of new products. The reduction
of discounts has also helped the growth in revenue per item as they have
reduced the discounts offered to 46% in 3Q19 from around 55-60% of the
unit price.

Source: Company Disclosure & LSR (*average retail price approximately RMB
24.00 per item)
Discounts are a major part of Luckin Coffee. In the absence of discounts, we

believe the customers could revert back to Starbucks or convenience store
coffee. Therefore, the revenue per item growth could have a negative effect
on customer retention and items per customer. On the other hand, a decline
in sales and marketing cost per item could lead to slower customer count
growth. Therefore, we are not confident in Luckin’s ability to breakeven by
3Q20 even if they manage to meet the challenging revenue per item and
sales and marketing cost per item targets.
Furthermore, breaking even is one thing and generating an EBIT margin

worthy of its current valuation is something else. In our opinion merely
breaking even is not enough to Justify Lukin’s $6.4bn EV.

— Oshadhi Kumarasiri (25 Nov 2019)

Luckin Coffee: Recent Spike in Arabica Coffee Prices to Affect Margin Improvement
Luckin Coffee: Recent

Spike in Arabica Coffee
Prices to Affect Margin
Oshadhi Kumarasiri
Improvement
Equity Analyst
By Oshadhi Kumarasiri | 19 Dec 2019
The price of coffee beans has risen sharply over the last few months as the
world's biggest suppliers of coffee have cut their production forecasts for the
next year. Meanwhile the worldwide demand for coffee continues to surge
with Asia leading the way.
D E TA I L
Luckin Coffee is a popular coffee shop chain in China with high revenue
growth and negative operating margin. Over the last few quarters, the
company has managed to gradually reduce its negative operating margin
though promotional cost /discount reductions and operating leverage.
During Luckin Coffee’s short history the coffee price remained close to a
five-year low level. However, the recent production forecasts have pushed
coffee prices up by about 50% in the last couple of months.
• Brazil is the largest producer of coffee in the world and the production
forecast for the next year was cut 10% due to a drought in the state of
Minas Gerais, Brazil's biggest coffee-producing region.
• Coffee production for 2020 is also likely to decline in other major coffee
producing countries such as Vietnam and Honduras.
• Additionally, the coffee inventory level is also expected to decline 40%

in the next year.
• As a result, the coffee price is expected to further increase in 2020 to

reach close to its five-year high level.

Source: Cap IQ
• Luckin Coffee generates over 74% of its revenue from freshly brewed
drinks and nearly all freshly brewed drinks are coffee. The company use
premium Arabica coffee beans in their coffee, and they are sourced
from plantations in Guatemala, Brazil, Ethiopia and Colombia.
• In one of our previous insights, we pointed out that per unit cost
reductions (operating leverage) are fading. Please refer the link below
to read our previous insight on Luckin Coffee
Luckin Coffee 3Q19 Quantamental Analysis: Price Hike Unjustified as

Marginal Cost Improvements Fade
• Material cost is currently at 47% of revenue and our marginal cost

analysis shows that there is little room for improvement from the
operating leverage side. Material cost per cup has settled at RMB 4.8
per cup for two consecutive quarters. This is an indication that our
marginal cost observations are somewhat accurate.
• Therefore, we expected the material cost as a percentage of revenue to

remain close to the current level. However, the increase in coffee price
was something we failed to capture in our initial forecasts.

• Luckin Coffee’s main material costs are coffee and milk. We have
analysed the correlation of per unit cost of materials with coffee prices,
milk prices and the sales volume. We believe operating leverage gains
from volume growth are almost over. Hence, there will be no/low
operating leverage gains in 4Q19 to offset the impact of the increase in
coffee price. As result we expect cost of materials as a percentage of
revenue to increase by 400bps in 4Q19 to reach 51%.
• However, Luckin Coffee’s share price hasn’t reacted to the increase in

coffee price.

Source: Cap IQ
Conclusion
• Luckin had a negative OP margin of 38% as of 3Q19 and we believe the

improvements from the cost side are fading rapidly. Therefore, we
expect the speed of margin improvement to slow down going forward.
The coffee price rose sharply while Luckin was already under pressure
to maintain its margin improvement trend. The coffee price is expected
to increase even more in the next year.
• Under such circumstances, it will be difficult for Luckin Coffee to

maintain its margin improvement trend and at negative 38% OP
margin, we feel a setback in margin improvement could prompt a
substantial share price correction.

— Oshadhi Kumarasiri (19 Dec 2019)

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Smartkarma Research How Luckin Coffee Spilt The Beans

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How Luckin Coffee Spilt the Beans

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professionals and management.

2. Luckin Coffee IPO: Wake up and Smell the Coffee ........................................................................................... 17

6. Luckin Coffee (瑞幸咖啡) - Blue-Sky/Bear-Case Valuation............................................................................... 54

11. Luckin Coffee (瑞幸咖啡) IPO Trading Strategies ............................................................................................. 91

16. Luckin Coffee’s Unit Cost Dynamics ................................................................................................................121

Luckin Coffee | Equity Capital Markets

Luckin Coffee (瑞幸咖

APAC IPOs & Placements

Trying the app

Zhen Zhou, Toh 4

Zhen Zhou, Toh 5

Zhen Zhou, Toh 6

Zhen Zhou, Toh 7

Zhen Zhou, Toh 8

Zhen Zhou, Toh 9

Zhen Zhou, Toh 10

Zhen Zhou, Toh 11

Zhen Zhou, Toh 12

Zhen Zhou, Toh 13

Channel checks - most were

Zhen Zhou, Toh 14

Zhen Zhou, Toh 15

Our channel checks seem to be consistent with the interviews done by

There were also many of these Luckin vs Starbucks comparison videos

Disclosure & Certification

— Zhen Zhou, Toh (23 Apr 2019)

Zhen Zhou, Toh 16

Luckin Coffee | Equity Capital Markets

Luckin Coffee IPO:

IPO and L/S equity, 2015

Intro to Luckin IPO

A great growth market beset by tough competition

Intro to Luckin IPO

Figure 1: Key stats for Luckin Coffee IPO

Amount to be raised $800mn USD

Total revenue 841mn RMB as of FY18

Revenue growth c336,000% yoy growth in FY18, 3594% growth in 1Q19

EBIT margin -190% margin in FY18, -110% margin in 1Q19

FCF (RMB) -2.6bn RMB in FY18, -828mn in 1Q19

Stores 2370 owned

Lead bookrunners CS, Morgan Stanley, CICC, Haitong

Source: GER research