Luckin Coffee: A Comeback with Rapid Store Openings

Before the US stock market opened on the evening of May 1st Beijing time, Luckin Coffee (LKNCY.OO) released its Q1 2023 earnings report. Despite the seasonal fluctuations and pandemic control measures in the previous quarter, Luckin Coffee still achieved impressive results. Same-store sales growth remained strong, which contributed to the explosive growth of total revenue surpassing 80% to reach a historic high, with both self-operated stores and franchise stores achieving record-high revenue.

The rapid expansion of stores did not affect same-store sales, which is a continuous support for store expansion. After same-store sales growth declined to 9% in the previous quarter, the 29% growth in this quarter undoubtedly injected new confidence to the market.

In the first quarter of this year, Luckin Coffee expanded rapidly, opening more than 1,000 net new stores, which is in line with its strategy to expand stores in county towns and increase the proportion of franchise stores to 33%. The new stores opened are aimed at exploring new markets rather than simply diverting mature store sales, which can provide a stable foundation for future store sales growth in the next four quarters. Luckin Coffee's goal at the beginning of the year was to reach tens of thousands of stores and achieve nearly 2,000 new store additions this year. However, it has already completed nearly 60% of its goal in just one quarter.

Although there is not much room for improvement, optimizing even small costs can still make a difference to profitability. With a regular profit margin of 7-8% during the low season, optimizing 2% can give more room for profit (compared to Q4 2022).

On the basis of extreme restraint in cost control in the previous quarter, the latest earnings report benefited from the revenue growth, which saw further dilution of management expenses and amortization. Management expenses and amortization were optimized by 2% and 1%, respectively. Coupled with the 8% profit margin in the fourth quarter of last year, the profit margin of the first quarter of this year soared to 15%.

With cost and expense optimization, the gross profit margin of store operations increased significantly from 23.6% in the fourth quarter to 25.2% this quarter, the gap between this quarter and last year's peak season is minimized. However, the impact of the high proportion of new stores needs to be considered. After store operations stabilize and the base becomes larger, there is still room for further improvement in the average profitability of each store. Dolphin's Overall View:

Considering that Luckin Coffee has already achieved a considerable revenue basis, it is acceptable that the quarterly revenue growth rate has gradually dropped from doubling to around 50%, but this year's Q1 saw a continuation of the past high-growth level. Although such high growth is due to the lagging demand (store opening demand) combined with the impact of joint reserve, it may rapidly fall in the next 2-3 quarters. However, in light of the good performance achieved in this period's same-store sales growth, Dolphin judges that even if the store expansion growth rate falls in the future, the newly added stores occupying excellent geographical positions can still provide strong support for revenue and profit.

Transitioning from the peak season to the off-season last year, some of Luckin's operating data saw a certain degree of optimization stagnation, but now, under the influence of sales driving, not only has the single-store revenue recovered rapidly, but cost optimization and expense optimization have begun again.

In the last financial report, we concluded that Luckin's first half had ended, and now the more important thing is the second half, the franchise sinking. After this period's financial report, we can conclude that Luckin Coffee, which is seizing the sinking market, still has an advantage.

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Detailed Analysis:

1. Single-store Sales Skyrocketed

In Dolphin's previous financial report commentary, it was mentioned that Luckin's single-store sales are still in a growth trend, but the same-store sales growth rate began to slow down in Q4 of last year. However, in Q1 of this year, it suddenly surged, with a single-store growth rate of 29.6%, which is very close to the level of the first three quarters of last year.

On the one hand, the hot scene was reflected in the "coffee going to the countryside" phenomenon at the beginning of the year, and on the other hand, it also proved that the impact of the epidemic prevention policy adjustment was quite significant in the fourth quarter of last year. Once the infection peak passes, high-frequency consumer goods such as coffee can quickly recover.

From the perspective of self-operated revenue, substantial growth was still achieved in Q1 of this year. Although the low base in the same period played a certain role in the 78% YoY revenue growth in this quarter, even from a single-quarter revenue perspective, the revenue of RMB 3.3 billion achieved in Q1 of this year was already historically the highest level, even higher than last summer's peak season (Q2) by 10%, fully reflecting that Luckin Coffee has not reached the end of its growth. Similarly, Dolphin once again conducted a rough breakdown of the sources of self-operated revenue. In the fourth quarter, we analyzed that 44% of the growth in self-operated revenue came from a 10% increase in the number of old stores (according to the company's statistics on the number of stores in the same store), a 9% increase in the same-store sales of old stores, and a nearly 20% increase in revenue contributed by new stores.

In the first quarter of this year, in addition to the driving factor of a 29% increase in same-store sales, the net increase in the number of new stores is still the main contributor of stable growth. Among several driving factors, the contribution of new stores is not only the highest, but also the growth rate has completely reversed the trend of streamlining stores and opening a small number of new stores in the past 2-3 years. The attitude of boldly and vigorously expanding is very obvious.

This is a very good sign. While maintaining the expansion of stores, it can also maintain the sales scale of individual stores, indicating that the geographical positioning of most of the stores is not in places where the market share is already high, but they are not simply diverting mature stores.

Combining with Luckin's current sinking strategy, we can even make a bold judgment, that even if the same-store sales growth rate in the second quarter does not continue to be at a high level, the expansion this time has basically obtained the best geographical locations in lower-tier cities, which is a solid foundation for Luckin's later development.

In addition, from the perspective of the Internet economy, it is still judged that Luckin still has growth potential. Judging from the monthly average transaction customers, it has reached nearly 30 million times, breaking new highs and pulling away from the past.

Second, store expansion speeds up, franchising "soars".

In the previous earnings report, we said that land acquisition is still the main melody of the company's expansion. Since the fourth quarter of last year, when it began to open up franchise operations, the market response has been very positive. However, due to the sudden increase in the infection rate in the fourth quarter of last year, store expansion actually slowed down.

At that time, some investors in the market were also worried that the slowdown in store expansion may not be entirely due to the epidemic. In the environment of the continuous squeezing by competitors, the competition pattern began to deteriorate, and Luckin itself may have encountered a bottleneck in expansion. However, the performance in the first quarter of this year is enough to prove that this argument is untenable.

In terms of quantity, although the increase in the number of self-operated stores is still the main contributor, from the trend of store competition in the past few quarters, we cannot underestimate the contribution of franchised stores. The growth of franchised stores has increased by almost 60% compared to the same period, and the proportion of franchised stores in the overall situation continues to increase, reaching 33% so far. At the beginning of the year, the company expressed confidence that it could break through 10,000 stores this year. Judging from the current number of 9,350 stores, this should be achievable.

However, we must remind everyone that although we believe that Luckin Coffee still has great potential for expanding its store network, it is definitely not going to maintain the level of rapid expansion seen in the first quarter of this year. The special circumstance in the first quarter is that, during the initial period in which franchisees were once again allowed to join, the company already had a certain foundation and could start expanding.

Part of the expansion plan for the fourth quarter was postponed to the first quarter due to limitations on expansion efforts. Under the dual effect of these factors, the net increase in the number of stores in the first quarter was indeed astonishing, but it will be difficult to maintain such rapid growth over the long term.

The growth rate will inevitably decline, but one positive aspect is that the quality of newly-added stores appears to be relatively high. They have not diverted business from existing stores, but rather created a new market. As of the previous quarter, Luckin Coffee's franchise stores had covered more than 230 cities, with an average of only 13 stores per city, which is far from saturation.

III. Single Store Model: Maintaining High Quality

Significant year-on-year growth in same-store sales indicates that there will be continued advancement in single-store revenue and profits.

Due to the transition from peak to off-peak seasons, single-store revenue fell from RMB 580,000 to RMB 520,000, and store operating profit fell from RMB 160,000 to RMB 110,000 in the fourth quarter of last year.

In contrast, single-store revenue had already recovered to RMB 550,000 during the first quarter, nearly reaching the peak level of last year. In addition, the store operating profit margin continued to increase to 25%. Although there is still a gap with peak season, due to the large number of new stores added in the first quarter, there was a significant drag on the company's overall measurement of single-store revenue and profits. As new stores gradually mature and output continues to improve, they will contribute to the company for at least the next four quarters.

Although there are no specific sales figures, based on the fact that self-operated sales reached RMB 3.3 billion in a single quarter (including sales from outlets other than self-operated stores), even if the ASP reached RMB 16.5, sales volume would still reach 200 million cups in a single quarter, or approximately more than 370 cups per day, which is still a relatively high level.

In the previous issue, we also mentioned that after the last marketing policy was cancelled, the ASP has returned to a relatively normal level, and stores have started to make profits after streamlining. If the future expansion continues to go deeper, the probability of continuing to raise ASP is not particularly high. Mainly, there is a lot of fat in the sinking market, and there are many players who want to share it.

According to reports, Kudikafu, a new brand of the original founder team, has opened more than 1,600 stores in the past seven months, averaging more than 200 stores per month. However, based on feedback from franchisees, the brand's operations have not yet reached a relatively profitable state. The cost per cup is still in the range of 6-9 yuan/cup, and it is difficult to achieve profitability if the average daily sales are less than 300 cups.

To cope with such a competitive environment, Luckin's approach is to maintain a low ASP while continuously outputting explosive new products. After the coconut latte, the ice-absorbing coconut and biluochun latte have begun to refresh consumers' vision and have achieved remarkable results.

IV. Joint cultivation

Based on the above impacts (single store sales growth plus rapid expansion of stores), Luckin's overall revenue in the first quarter was 4.4 billion yuan, an increase of 85% year-on-year. In addition to the self-operated 3.3 billion yuan, the franchise contributed more than 1.1 billion yuan, both of which reached a historical high level. Moreover, from the perspective of store contribution, they are basically stable or slightly improved, rather than relying solely on opening stores to increase revenue.

V. Cost allocation and expense optimization

As a key factor for the company's growth quality, the trend of cost and expense changes is an issue that must be of concern. However, at the current level of single-quarter sales of more than 200 million cups, the amortization of rent has relatively entered a stable range.

1) Gross profit and cost:

Luckin's gross profit in the first quarter was 1.8 billion yuan, the highest level in history, with a gross profit margin of 40%, showing a very obvious increase over the same period last year and the previous quarter. However, the relatively rigid rental costs, influenced by the amortization of single-store sales, have still shown some optimization and decreased to around 20%.

At such a scale, the future improvement of gross profit margin (mainly self-operated) may encounter some bottlenecks (it may further decrease during peak season, but it will recover during the off-season, showing quarterly fluctuations)

Expense aspect:

Luckin's cost-side elasticity comes from store rent and other operating costs, while the scale elasticity of expenses mainly comes from depreciation, sales, and administrative expenses. From the perspective of past situations, the main area for optimization of sales expenses after passing the crazy marketing period of discounts and promotions is in management expenses (around 10% in the fourth quarter of last year) and amortization and depreciation (around 4%).

This narrow space underwent significant changes in the first quarter of this year. In the extreme environment of the fourth quarter of last year, in addition to store expenses such as rent, the corresponding ratio of management and sales expenses increased, as single-store sales volume decreased on a month-to-month basis.

In the first quarter of this year, single-store sales grew significantly, and management expenses and amortization and depreciation were to some extent diluted and compressed, with a year-on-year decrease of 5% and 2%, respectively; a month-over-month decrease of 3% and 1%, respectively. For the coffee industry, whose profit margin is at the level of 8% (in the offseason of the fourth quarter), this decrease is undoubtedly a huge stimulant.

In the last quarter, we said that Luckin Coffee had already turned over after undergoing a major overhaul, and what will follow is a sprint after reshaping the organization. After reading this quarter’s financial report, we can say that Luckin Coffee has once again stepped on the accelerator on the road of sprinting.