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Thursday, February 9, 2023

Luckin Coffee Is Still Risky After Its Slap-on-the-Wrist Fine

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Luckin Coffee (OTCMKTS:LKNCY), the controversial, downtrodden Chinese coffeehouse operator, is finally taking some steps in the right direction, but Luckin stock remains a gamble.

Four Luckin Coffee (LK) coffee cups are arranged in a row.

Source: Keitma / Shutterstock.com

Still reeling from the effects of a revenue-inflating scandal that took Luckin from being a Chinese growth darling to trading over-the-counter, the company recently reappointed Sean Shao, one of its four independent directors, to the board.

Board appointments usually don’t move stocks. But in Luckin’s case, Shao’s reappointment was positive because it indicates the company, once plagued by corruption at the top, is prioritizing independence on its board.

There’s chatter that at some point, Shao, who led Luckin’s internal investigation into the scandal, could eventually become chairman. Speaking of the scandal, China’s finance ministry recently fined the coffee company nearly $9 million. All things considered, that’s a minor punishment, given the gravity of the situation.

“We have carried out an overall rectification on the related issues,” the company said on the Chinese messaging platform, Weibo. “We will further improve our operations according to related laws and regulations.”

Where Will Luckin Stock Go from Here?

Any whiff of somewhat positive news moves Luckin’s shares. For example, it shot up more than 13% on news of the aforementioned, meager fine, These days, those are the breaks with low-priced, controversial stocks. But that doesn’t make the shares a solid long-term investment; it makes them good for trading.

Luckin is doing what it can to shed its controversial label. Last week, the company said it dismissed its previous auditor, Ernst & Young, and hired Marcum Bernstein & Pinchuk LLP instead.  But the company maintains that the move was not triggered by the revenue-inflating scandal.

Board appointments, dodging large fines and changing auditors are incremental steps on what’s going to be a long recovery for Luckin. But it’s going to take more to regain investors’ trust, and recapturing trust is crucial for Luckin’s rebound aspirations. The silver lining for Luckin is that regaining lost trust is hard, but not impossible.

Researchers who performed a 2014 study for the Stanford Graduate School of Business analyzed 10,000 press statements from companies that intentionally misstated their results. They discovered that, on average, an accounting scandal can cost a company 27% of its pre-controversy market value. However, the study suggests that Luckin should also seek to improve its reputation among other groups.

“Moreover, 51% of the reputation-repair efforts were aimed at softer constituencies. Of 898 announcements in the year after restatements, 216 were aimed at local communities, 189 were aimed at customers, and 54 were aimed at the firms’ employees,” according to the study. “On average, shareholders responded favorably to all of it. After separating out the effect of other market movements, the researchers estimate that announcements of reputation-repair actions lifted share prices.”

Still Flying Blind

It’s possible that Luckin can build a solid corporate culture and engineer a reputational turnaround. But it will take time for the company to accomplish that goal.

Until then, Luckin stock still carries considerable risk  because the company hasn’t provided financial results in over a year. The primary gauge most investors use to make “buy” decisions on any given stock is earnings power. For young growth companies that are not yet profitable, market participants are paying for revenue growth.

To decide whether to buy stocks, investors need financial information, and Luckin isn’t supplying that. Investors can fly blind into Luckin stock right now in an effort to benefit from its recovery, but they would be doing so without reliable financial data on the company. Without Luckin’s top line and earnings data, the name is a gamble, and investors should leave gambling to their trips to Las Vegas.

On the date of publication, Todd Shriber did not have (either directly or indirectly) any positions in any of the securities mentioned in this article.

Todd Shriber has been an InvestorPlace contributor since 2014.

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