Luckin Coffee Inc

OTC:LKNCY

Earnings Call Analysis

Luckin Coffee Posts Solid Growth Amidst Challenges

In Q3, Luckin Coffee navigated a fiercely competitive industry to deliver robust revenue growth, driven by an innovative business model, scale advantages, and store expansion. Revenues surged 84.9% year-on-year to RMB7.2 billion with a 19.9% increase in same-store sales but the company saw a decline in profit margins to 23.1% for self-operated stores due to product price reductions and rising operational expenses, partly balanced by cost control and efficiency improvements. The company boasts 58.5 million monthly customers, marks a vibrant 133% YoY growth, and remains focused on expanding market share with affordable, high-quality products. Luckin ended Q3 with RMB5.7 billion in cash, no debt, and a confident outlook, despite a probable margin dip in Q4 due to product mix and raw material costs. Recent leadership changes reflect a continued commitment to growth and organizational excellence.

A Robust Financial Performance with Expanding Market Presence

The company demonstrated a powerful financial performance, with total net revenue reaching RMB7.2 billion, marking an impressive 84.9% growth year-on-year. Their commitment to long-term growth is evident through key strategic moves to expand their store network rapidly, aiming to escalate their market share.

Optimizing Operating Dynamics while Fostering Consumer Relationships

The company’s customer base has grown significantly, with average monthly transacting customers reaching 58.5 million, driven by store expansion and successful product launches like the Jiangxiang Flavored Latte. This customer focus is further bolstered by plans to reward loyalty and enhance relationships with business partners, evidenced by a new policy to shorten the payment period to 30 days starting from 2024.

Maintaining Financial Soundness with No Debt

A strong financial position is maintained with RMB5.7 billion in cash and no interest-bearing debt. The company also posted a positive operating cash flow of RMB1.3 billion for the quarter and achieved a year-to-date free cash flow of about RMB402.3 million.

Solid Profitability and Margins Despite Market Challenges

The company's net income stood at RMB988 million, translating to a net profit margin of 13.7%; adjusting for deferred tax assets, the net profit was RMB736 million or a 10.2% net profit margin. The operating profit margin for self-operated stores was at a healthy 23.1%, although this represents a decrease from the previous year’s 26.9%.

Marketing and Administrative Expenditures: Scale and Strategy

Investment in branding and marketing increased, pushing the sales and marketing expenses ratio to 5.3%, up from 4.1% in the same quarter of the previous year, reflecting strategic promotional efforts. General and administrative expenses rose by 25.5% year-over-year, but decreased as a percentage of revenue from 9.9% to 6.7% due to scale benefits.

E-commerce Investments and Expense Management

Increased commission fees to third-party delivery platforms and subcontractor service fees to support e-commerce and promotional activities accounted for higher expenditure in line with the growth in delivery orders.

Corporate Governance and Management Transitions

The company has updated its provision for equity litigants in accordance with accounting standards, while also introducing fresh leadership with the promotion of four young senior management professionals to bolster the brand’s appeal to younger demographics.

Cultural Shifts and Future Growth

There's a commitment to continue providing customers with quality and affordable products, aiming to explore further the potential of China’s coffee market. Moreover, a leadership change is on the horizon with the Chief Strategy Officer moving to an external consultant role, marking a transition with a focus on continued support for the brand's strategic objectives including its growth into a world-class brand.

Earnings Call Transcript 2023-Q3

[Operator]

Ladies and gentlemen, welcome to Luckin Coffee's Third Quarter 2023 Earnings Conference Call. [Operator Instructions] Today's conference is being recorded.

At this time, I would like to turn the call over to Ms. Alicia Guo, the Head of Investor Relations of Luckin Coffee, for prepared remarks and introductions. Please go ahead, Alicia.

[Alicia Guo, executive]

Hello, everyone, and thank you for joining us on today's call. Luckin Coffee announced its third quarter 2023 financial results earlier today. Today, you will hear from Dr. Guo Jinyi, Chairman and CEO of Luckin Coffee; Ms. An Jing, CFO of Luckin Coffee; and Mr. Reinout Schakel, CSO of Luckin Coffee.

After the company's prepared remarks, the management team will conduct a question-and-answer session based on questions submitted via the company's webcast.

We will be referring to a slide presentation on today's call. which can be found via a conference call webcast link as well as on the company's IR website. The IR website ink is investor.lkcoffee.com.

During today's call, the company will be making some forward-looking statements regarding future events and results. Statements that are not historical facts, including, but not limited to, statements about the company's beliefs and expectations are forward-looking statements. Forward-looking statements involve inherent risks and uncertainties. Further information regarding these and other risks is included in the company's filings with the SEC.

With respect to any non-GAAP measures discussed during the call today, the accompanying reconciliation information related to those measures can be found in the earnings press release issued earlier.

During today's call, Dr. Guo will speak in Chinese and his comments will be translated into English.

Now I would like to turn the call over to Dr. Guo Jinyi, Chairman and CEO of Luckin Coffee. Dr. Guo, please go ahead.

[Jinyi Guo, executive]

[Interpreted] Hello, everyone. Welcome to today's earnings conference call, and thank you for continuing to support Luckin Coffee. I am the Chairman and CEO, Guo Jinyi.

In the third quarter, despite the industry's intense competitive landscape, we achieved high revenue growth, thanks to our distinctive business model, continuous product innovation and scale advantages. Both the number of Luckin Coffee stores and new transacting customers increased rapidly and reached historic heights. At the same time, we continue to reward our customers through the 10,000-store celebration event, which allowed customers to enjoy high-quality coffee at a more favorable price.

During the third quarter, we also achieved a remarkable feat of introducing a top-selling product that surpassed our previous single-item sales record.

We will continue to make steady progress by executing our established strategy and continue to expand our market share while giving back to our customers. We're committed to providing consumers with coffee products of high quality, high affordability and high convenience, driving the development of the Chinese coffee market.

Taking a granular view, revenue continued to grow rapidly in the third quarter while profit levels saw a slight decline. Total net revenue was RMB 7.2 billion, representing an 84.9% year-on-year increase. Operating margin was 13.4%. Meanwhile, profit margin for self-operated stores was 23.1% with a same-store sales growth rate of 19.9%.

Additionally, there were 2,437 net new store openings in the third quarter, bringing the total number of stores to 13,273 as of the end of this quarter. The cumulative number of transacting customers exceeded 200 million with an average monthly transacting customers exceeding 58 million in the third quarter. Our CFO, An Jing, will provide further details on the financials later.

In the third quarter, we have more than 2,400 net new store openings, bringing the total number of stores to 13,255 in China as of the end of the quarter. We continue to lead the market as the largest coffee chain brand in China based on store counts. Among the total number of stores, there were 8,789 self-operated stores and 4,466 partnership stores.

As competition in the coffee market in China intensifies, we will continue to expand our presence in high-tier cities and accelerate our penetration in new markets through our partnership model. We expect that by the end of this year, the number of Luckin Coffee stores will exceed 15,000.

At the same time, the number of Singapore stores reached 18 as of the end of the quarter with an addition of 11 stores compared to the end of the second quarter. In the future, we will continue to expand into international markets so that more consumers around the world can enjoy our high-quality coffee.

In terms of products, in the third quarter, we launched 12 freshly brewed products and successfully collaborated with Kweichow Moutai to create popular Jiangxiang-flavored latte, which broke our single-item sales record with an impressive 5.42 million cups sold on launch day and surpassed RMB 1 billion in single items. While the new products performed exceptionally well, our Velvet Latte series also reached a milestone in September with sales volume surpassing 200 million cups since its launch.

Furthermore, to celebrate 1-year anniversary of the launch of our cheese-flavored latte, we recently reintroduced mascarpone latte, which achieved a first week single-item sales volume of more than [ 16.24 ] million cups.

Going forward, we will continue to focus on product innovation, aiming to provide customers with a higher quality and fresher experience through innovative items such as Jiangxiang-flavored latte and mascarpone latte.

With the combined effect of accelerating store expansion and continuous product innovation, we have gained over 30 million new transacting customers in the third quarter with an average monthly transacting customers exceeding 58 million, reaching a historic high. As of the end of the third quarter, our cumulative consumer base has exceeded 200 million.

We have formulated a sustainable development strategy, Being a force for a brighter future, to guide our sustainable development efforts. The overall strategy is divided into 3 parts: boosting the sustainable business, co-building a responsible value chain and improving a better planet with support of digital and intelligent empowering. The strategy represents our vision and [ practice ] direction of sustainable development for ourselves, our value chain and for the broader social environment. As is indicated by the digital and intelligent empowering text, the strategy is being bolstered by Luckin's core advantage of digitalization.

As part of this report, we completed a carbon inventory and verification for the whole company for the first time. We also completed the carbon footprint verification of Coconut Milk Latte and latte for the first time. According to the in-depth understanding of carbon emission of our operations and products, we can lay the data foundation for our future carbon reduction strategies and to drive research to develop more low-carbon products.

In the future, we will focus on the core issues of sustainable development strategy, further developing our Sustainable Development Goals, accelerating the implementation of Sustainable Development practices with the company and collaborating with partners and consumers to create a better future. These are the key highlights of our performance in the third quarter.

Next, I would like to invite our CFO, An Jing, to present the financial data and commentary.

[Jing An, executive]

Thank you very much, Jinyi. Good morning, afternoon and evening, everyone. Thank you for joining us today. I'm An Jing, the CFO of Luckin Coffee. And today, I will provide an overview of our financial performance for the third quarter of 2023.

Before we start, I want to convey my thanks to our committed staff, loyal customers, esteemed partners and cherished investors for their support.

Now I will take some time to overview our 2023 third quarter results in detail. Let's start with our financial highlights. Our revenue once again hit a record high of RMB 7.2 billion, growing 84.9% year-over-year in the third quarter. As a result of our efforts to expand our market presence, growth in net revenues was predominantly driven by the expanded sales volume, increased number of operational stores and the rise in the count of monthly transacting customers.

Meanwhile, we kept rolling out promotional campaign during the quarter. At the same time, our product launches during the quarter were very popular with existing and new customers.

During the quarter, both our self-operated and partnership stores performed well. Self-operated revenue reached RMB 5.1 billion with a growth rate of 79.3% driven by the rapid store expansion as well as the increased sales volume. Meanwhile, our partnership stores demonstrated strong growth with an increase of 104.7% year-over-year, reaching over RMB 1.8 billion in revenue.

Turning to profitability. We remain committed to financial discipline and strategic focus as we execute our market share expansion strategy through aggressive store expansion to attract more new customers. In doing this, we had more than 2,400 new store opening during the quarter and maintained our pricing strategy, which have effectively reflected in the increased sales volume and a lower margin profile while increasing the operating profit dollar values.

As a result, operating profit margin decreased to 13.4% from 15% in the same time last year while operating profit grew to RMB 962 million from RMB 585 million. We view this decline in margin as a strategic shift as we aim to acquire more customers and maximize market share in China's competitive coffee market.

Let's now take a closer look at our store network. In the third quarter, the number of stores reached a total of 13,273, which represents a total expansion rate of 69.2% compared to the same period of last year. During the third quarter, we had 2,437 net new store openings. Of these new store openings, 1,619 were self-operated stores and 818 were partnership stores. Our dedication to expanding our breadth and catering to the diverse needs of our customers is demonstrated in the steady growth of our store network, both self-operated and in partnership.

At the same time, we have made strategic efforts to expand our geographic reach. In the third quarter, we operated self-operated store in 73 cities across China with 1 overseas market. Meanwhile, our partnership stores expanded our footprint to 287 cities in China. We remain committed to diversifying our geographic presence and capturing new market opportunities.

During the quarter, we reached 58.5 million average monthly transacting customers, a substantial increase from 25.1 million in the previous year demonstrating our ability to attract customers. This growth was a result of store expansion to new geographies and new traffic driven by the popularity of our Jiangxiang-flavored latte.

Next, I would like to spend some time to discuss the details of our margin and bottom line profile. On a group level, we reported net income of RMB 988 million or a net profit margin of 13.7% for the third quarter. If excluding the deferred tax asset valuation allowance release of RMB 252 million, the net profit would be RMB 736 million or a net profit margin of 10.2%.

During the third quarter, we reevaluated the recognition of deferred tax assets given the largely reduced uncertainty of the company's business performance after a certain number of the company's operation entities have turned cumulative profits. As a result, we reversed the recognition of approximately RMB 252 million in valuation allowance against our deferred tax assets.

From a store level view, for our self-operated stores, the operating profit margin was 23.1% in the third quarter of 2023 compared to 26.9% in the same period of 2022. The decrease was primarily due to the decrease in average selling price of our products, offset by the benefits of a scale from the increased product volume sold.

Meanwhile, overall operating expenses increased as volume increased and operationally expanded, offset by enhanced efficiency through cost control, technology-driven operations as well as scale advantage.

Our general and administrative expenses on an absolute value basis increased by 25.5% year-over-year. While the G&A expenses as a percentage of revenue decreased from 9.9% in third quarter of last year to 6.7% in the third quarter of this year due to scale benefits.

The sales and marketing expenses ratio rose to 5.3% this quarter from 4.1% in the same period of last year as we continue to strategically invest in branding to increase brand awareness and bolster the current positioning through various channels, including collaboration with Kweichow Moutai and the launch of Jiangxiang-flavored latte.

Meanwhile, in this quarter, we spent more on commission fees to third-party delivery platforms due to increase of delivery orders as well as more on subcontractor service fee to support the e-commerce business and promotional activities.

In addition, we are glad to share that the expenses related to Fabricated Transactions and Restructuring, which consisted primarily of professional and the legal fees of securities litigation and other advisory service fees, were RMB 3 million or 0% of net revenue in the third quarter compared to 0.2% in the same quarter of last year.

At the same time, we have also updated our provision for equity litigants based on developments that occurred in the third quarter in accordance with the relevant accounting standards.

Let's now turn to balance sheet and the cash generation. We ended the third quarter with RMB 5.7 billion of cash at bank and on hand and 0 interest-bearing debt. Our healthy balance sheet and strong cash on hand has provided us with competitive advantage in this uncertain financial environment as well as providing additional growth potential.

In addition, we achieved a positive operating cash flow of RMB 1.3 billion in the quarter, which is around USD 179.6 million compared to RMB 416.9 million in the same quarter of 2022. Free cash flow year-to-date through the third quarter was about RMB 402.3 million.

To conclude, while we expect volatile customers and market dynamics and the competition to continue, we remain confident in our strategy and the results it delivers. As we look to the remainder of the year, we are confident in our current pricing strategy, strategic promotional calendar [ and our planned ] product offerings.

We are committed to continue to adhere to our long-term growth, maintaining the current pricing strategy, rapidly expanding our store network and further increasing our market share, all the while providing customers with high-quality and affordable products in the long run.

I will now turn it over to Jinyi for concluding remarks followed by Q&A.

[Jinyi Guo, executive]

[Interpreted] The rapid growth of Luckin Coffee is the result of the joint efforts of our nearly 70,000 hardworking employees as well as the love of our customers, the support of our partners and the trust of our investors. We would like to express our heartfelt gratitude to all of you.

At the same time, to enhance mutual trust and win-win relationships among business partners, at the recent Luckin Coffee partnership summit, we announced that we will shorten the payment period to 30 days starting from 2024 to jointly build a healthy competitive environment and promote the standardized development of the overall industry.

Going forward, we will continue to reward our customers with the long-term returns and further explore the potential of China's coffee market. We will continue to deliver better quality and better prices and provide customers with a coffee that is delicious and affordable. We will continue to focus on the long-term value of our brand and aim to make Luckin Coffee a world-class brand. And we will work towards achieving long-term, healthy, high-speed and sustainable growth.

As we continue to expand, strong organizational capabilities are the foundation of our business development and are increasingly essential to the sustainability of our continuous growth. To further align with our strategic goals and business needs, enhance collaboration and boost efficiency, in the third quarter we promoted and introduced 4 senior management professionals who are post '80s generations with outstanding leadership skills, including a senior vice president responsible for the human resource department and 3 vice presidents overseeing core areas such as coffee supply chain; and IT technology, including IT products IT operations and IT architecture.

We believe that they will be able to tap into the creativity of a young team and use their professional capabilities and passion to help Luckin Coffee, a brand similarly useful and fashionable, to grow rapidly and continuously meet the diverse needs of our young customers.

At the same time, for personal reasons, Mr. Reinout Schakel, our Chief Strategy Officer, will depart from his position as Chief Strategy Officer at the end of the year. He will continue to provide strategic support to us in the capacity of an external consultant.

Over the past 5 years, Reinout has worked and stood side-by-side with us through our most challenging times. We have faced the challenges as a team and overcame difficulties together.

I would like to express my sincerest gratitude to Reinout for his hard work and tireless efforts over the past 5 years. We're confident that Reinout will continue to provide support for our development after the change in roles.

[Reinout Schakel, executive]

Thank you, Jinyi, for your kind words and giving me the opportunity to elaborate on the upcoming change in role.

I joined Luckin Coffee in January 2019 as CFO and CSO and have been with the company for almost 5 years. During that period, the company has encountered many ups and downs and our journey has been challenging at times. However, under Jinyi's leadership, we've collectively been able to overcome these challenges, and today, the company is in its strongest position yet.

I feel privileged and very proud that I've been able to contribute to the company's success and incredible turnaround story by overseeing various private and public financing rounds, leading our successful offshore financial restructuring, reorganizing our finance team and functions, reverting to normalized financial reporting and helping to build the foundation for our international expansion.

With the company in a position of strength, it is an appropriate time for me to consider my priorities and have therefore decided to resign from my current position as Chief Strategy Officer by the end of this year.

My journey at Luckin has been truly remarkable. I have gained invaluable experience that has shaped me as a professional and made lifelong friendships. Whilst my achievements at Luckin Coffee are something I'm incredibly proud of, like all of us, I've had to make many sacrifices during this time. Being able to spend more time with my young children and family has been an important factor in my decision to resign.

I'm honored that I've been offered a role as an external consultant and that I have had the opportunity to continue to support Luckin Coffee in various areas including, for example, growing Luckin Coffee into a world-class brand and supporting our capital markets strategy, albeit in a supporting role. At the same time, I will also have the opportunity to explore personal projects and ambitions in Hong Kong, focusing on charitable work for causes close to my heart.

I would like to thank our Board of Directors and our management team for their trust, support and guidance; all of our shareholders for their support and sticking with us through very challenging times; and all of our outstanding Luckin employees for their exceptional dedication, perseverance and hard work.

A special thanks to Jinyi, who helped facilitate a shift in our corporate culture towards transparency, accountability, integrity and professionalism; oversaw the implementation and execution of our revised corporate strategy; and brought us all together with a single-minded goal of redemption.

It has been an absolute pleasure working alongside you and the rest of our highly talented, principled and courageous management team in achieving that objective. Thank you.

[Alicia Guo, executive]

Thank you, Dr. Guo, Ms. An and Reinout. Now we would like to open the floor to questions.

[Operator]

Ladies and gentlemen, we will now begin the Q&A session. I will turn the call over to Alicia Guo at Luckin Coffee, who will moderate today's Q&A session.

[Alicia Guo, executive]

Thank you. Now let's begin with the first question. Congratulations on the solid third quarter results. We noticed that in this quarter, the company's margins have declined while facing the fierce competition in the Chinese coffee market. How does the company perceive the margin outlook?

[Jinyi Guo, executive]

[Interpreted] Thank you for your question. Although we saw margin declines this quarter, it was within our strategic expectations. China's coffee industry is experiencing rapid growth with huge growth potential, and the industry is increasingly competitive. Since the market is far from saturation, taking market share has become the priority for future development.

In light of this, we will continue to focus on customer value and to reduce our customers' decision-making costs and further expand our consumer base while continuously increasing consumption frequency by offering high-quality products with affordable pricing.

In the third quarter, our average monthly transacting customers exceeded 58 million, marking a 133% year-on-year growth. Therefore, based on our strategic decisions to consistently reward customers and expand the market, we're satisfied with our quarterly performance.

Facing the current intensified competition, as a market leader, we will continue with the current store expansion and pricing strategies and long-term returns to our customers to further enlarge our market share.

In the fourth quarter, considering seasonality and changes in product mix, raw material costs may further increase. As a result, there may be a decline in our profit margin. However, as we further strengthen and execute our core strategic goals to increase market share and attract new customers, we're confident that we can maintain and solidify our market-leading position and strive for long-term value.

[Alicia Guo, executive]

Thank you, Dr. Guo. Let's move on to the next question. Can you please provide additional color on net income and the deferred tax asset adjustments in this quarter?

[Jing An, executive]

Thank you for your questions. The significant difference in net income, which was reported as RMB 988 million instead of RMB 736 million, can be attributed to key accounting adjustments related to our income tax and deferred tax assets, which results in a significant reduction in the income tax expenses.

In the third quarter of 2023, we reported an income tax benefit of RMB 82.6 million compared to the income tax expenses of RMB 206.3 million in the same period of 2022. This change demonstrated a favorable shift in our income tax dynamics.

As I mentioned earlier, during the third quarter of 2023, we reevaluated the recognition of our deferred tax assets. This reassessment was based on our improved business performance as several of our operating entities transitioned from a cumulative loss to cumulative profit which, in turn, significantly reduced the uncertainty surrounding the future realization of these assets.

In light of the improved financial performance and the brighter outlook, we made the strategic decisions to reverse the recognition of about RMB 252.1 million of the valuation allowance against our deferred tax assets.

This valuation allowance had initially been established to account for uncertainties regarding the realization of these deferred tax assets. This accounting adjustment reflected our improved business performance and our increased confidence in the realization of deferred tax assets. It is a positive indication of our company's financial health.

[Alicia Guo, executive]

Thank you, Ms. An. The next question is, any updates to the company's capital markets strategy?

[Jinyi Guo, executive]

[Interpreted] Thanks for this question. We will continue to monitor the U.S. capital markets, but our priority is to execute our business strategy by focusing on our business operations. Right now, as we face historic development opportunities, our primary task is to implement our strategy by delivering exceptional products and services to our customers, aiming to capture a larger market share and provide sustainable long-term value to our shareholders.

We will continue to monitor the capital markets, but there is no specific time line or schedule for listing on any neighboring market.

[Alicia Guo, executive]

Thank you, Dr. Guo, Ms. An. That is all the time we have for today's earnings conference call. We thank you for your participation on today's call. We look forward to providing you with regular business updates, and look forward to speaking with you again next quarter.

[Operator]

This concludes our call today. You may now disconnect. Thank you.

[Portions of this transcript that are marked [Interpreted] were spoken by an interpreter present on the live call.]