Before the U.S. stock market opened on the evening of July 31st Beijing time, $Luckin Coffee(LKNCY.US) released its Q2 2024 report. Boosted by the peak season effect and the reduction in prices to 9.9 yuan, Q2 performance rebounded as expected. The most criticized profit side in Q1 quickly recovered, and the number of paying users that Dolphin was concerned about also returned to a growth path.

Overall performance exceeded Dolphin's expectations, but we previously learned that some investors had high expectations, even very optimistic ones. For them, it may just be a small beat or meeting expectations.

However, some indicators still show signs of saturation in the track (phase), which may affect the pace of future store openings, thereby impacting the market's medium to long-term growth expectations for Ruixing.

Specifically:

1. Turning losses around, just takes a peak season: Q1 saw losses due to the "off-season + subsidies," while Q2 saw profits from the "peak season + reduced subsidies." In addition to changes in revenue, there were also optimizations in cost expenses on a month-on-month basis, mainly reflected in product material cost rate, depreciation and amortization rate, and management expense rate.

The operating profit margin at the level of self-operated stores finally recovered to 21.5%, an increase of 15 percentage points compared to the previous period; the group achieved a net profit attributable to the parent of 871 million yuan, with a profit margin of 10.4%. Although it has not yet returned to the level of the same period last year, it has improved significantly compared to Q1.

2. Slowing store openings + same-store decline + cross-border new products = industry gradually saturating?: However, compared to the market's focus on short-term profit situations under price competition, that is, EPS, Dolphin is actually more concerned that in an economic downturn, the logic of domestic coffee penetration has reached its final destination prematurely. This situation will lead to more severe impacts on the diversion of new and old stores, which will quickly stagnate store openings, thereby affecting Ruixing's long-term growth prospects, corresponding to the PE valuation multiple. (Dolphin currently holds a cautious view on Ruixing's overseas prospects)

(1) Slowing store opening pace:

Looking at the number of new store openings, Ruixing significantly slowed down in the second quarter, with self-operated stores mainly lagging behind, possibly due to some pressure on net cash flow from several quarters of supplier subsidies. The growth of franchise stores also increased at a lower rate compared to Q1, but the pace of franchisees opening stores depends not only on the payback period of franchisees (whether the industry is saturated) but also on whether franchisees have extra money on hand to use as a one-time investment after opening stores (related to the economic environment).

(2) Same-store sales still declining:

Although store openings slowed in Q2, the current pace of store openings is not entirely rational, and the actual single-store model has been significantly affected.

Q2 same-store total revenue fell by 20.9% year-on-year, resulting in a 45% decline in revenue per single store. Despite the better year-on-year comparison of the gross profit margin per cup of products in self-operated stores, the operating profit margin has not returned to normal levels yet

However, due to the strategic approach of "seizing high-quality locations in advance", despite Cotti Coffee's lack of net new additions, Luckin still maintains its year-end target of 23,000 store openings.

(3) Recovery of paying users may come from new product expansions:

Apart from the performance in Q1 exceeding expectations, what concerns us the most is that while the pace of rapid store expansion remains unchanged, the number of paying users has decreased compared to the previous period. In a growing industry with significant room for penetration, the off-season should not be a core reason for this decline.

In Q2, the number of paying users has resumed growth, with the total number of paying users approaching 70 million for the quarter. In addition to natural growth from peak seasons and new store openings, we believe this growth is closely related to the new light coffee products launched in the second quarter. Similar to fruit tea, light coffee is also suitable for the weather in the second quarter, to some extent helping Luckin Coffee break through from coffee users to non-coffee users.

Combining the above points, while Dolphin is pleased with the recovery of Luckin Coffee's performance, concerns about industry saturation have not diminished significantly.

3. Overview of Performance Indicators

Dolphin's Viewpoint

In the previous quarter's financial report review, due to weak short-term demand and the impact of price wars, Dolphin suggested calculating the bottom value of Luckin Coffee and provided a reference range based on our estimate of $4 billion to $5 billion, i.e., $3 billion in profit by 2025, at a low-growth P/E ratio of 10x to 12x for the catering sector.

Subsequently, Luckin Coffee's market value dropped to a minimum of $3.7 billion. However, apart from factors such as weak fundamental expectations, there was also pressure on the stock price due to trading activities between shareholders within Da Zhen Capital's internal funds. Last week, the internal share transfer by major shareholders was completed, and the announcement indicated that the price of this targeted transaction was close to the previous lowest stock price, aligning more closely with Dolphin's conservative estimated lower limit.

1. However, after a quarter of strategic adjustments, the bottom price thinking may no longer be suitable for Luckin Coffee at present.

1) Peak season + new tea-like beverages jointly increase store revenue and profitability - The second quarter is the turning point between off-peak and peak seasons. Although the cold weather at the beginning of the quarter continued, the increase in cup volume was not as significant as the newly launched products by KFC. However, the light coffee series launched in June during the Dragon Boat Festival holiday sold exceptionally well, significantly boosting cup volume (estimated qoq +12% for self-operated stores).

Light coffee, similar to fruit tea products, emphasizes sweetness over the awakening function of coffee, effectively expanding Luckin Coffee's user base. In addition, the default "extra-large cup + ice" option effectively increases ASP and reduces costs, resulting in a higher gross profit margin for this product. According to Dolphin's estimation, the gross profit margin per cup of goods in Q2 for self-operated stores increased by 1 percentage point.

By June, the sales proportion of this product was close to 10%, and with the weather warming up in the third quarter and increased offline entertainment during the summer, the proportion is expected to further increase, positively impacting the gross profit margin

2) Luckin's Attitude Change Towards Price Wars - On one hand, due to the natural increase in demand during the peak season, overall promotions have been relaxed. On the other hand, they have shifted from "single-cycle promotions" to a "dynamic promotion" strategy based on competitor performance.

For example, when a competitor (Cotti Coffee) saw outstanding growth in cup volume in May due to the launch of a tea-coffee series, Luckin increased the distribution of Douyin cash vouchers. When Luckin launched a similar product, the Light Coffee series, in June and saw a significant increase in cup volume surpassing the competitor, they also reduced the quantity of cash vouchers.

(1) - (2) Both of the above changes directly reflect a decrease in the cost of subsidies to suppliers, thereby easing the group's profit pressure. At the same time, self-operated stores benefit from the peak season and new products. Whether it is the speed of following up on similar products, frequently launching co-branded products, or intercepting upstream raw materials for Cotti Coffee's new products, it confirms Luckin's consistent advantage over Cotti Coffee in product development capabilities and control of the upstream supply chain.

Therefore, the company's profit scale in the short to medium term is expected to be better than our original expectations, with profits expected to continue to increase to 25/33 billion in 24/25.

2. On the other side of the coin, industry saturation and competitive challenges have not eased.

Luckin's proactive withdrawal from the 9.9 yuan price war did not bring down Cotti Coffee. In addition to the repeated promotional actions of other cost-effective coffee brands, competition challenges within the industry are expected to continue for some time (Cotti Coffee lacks motivation to close stores during the peak season). Moreover, cross-border competitors such as milk tea are worth paying more attention to.

Especially in the saturated coffee track, the further impact of the downward trend in the overall environment has affected the penetration logic of coffee in the sinking market. Therefore, in terms of the P/E valuation multiples reflecting the company's growth potential, it is difficult to return to the previous level of 20-30x. However, with the improvement in profit expectations, the current valuation is not considered high. For how to deal with competition in the industry under saturation in the future, it is recommended to pay attention to the management's related answers during conference calls.

Below is a detailed analysis.

I. Store openings slowing down, same-store decline still not improving

As expected in the first quarter report review by Dolphin Jun, Luckin's store opening speed in the second quarter has significantly slowed down compared to the first quarter, but overall, it still leads among peers in the current catering industry. In Q2, there was a net addition of 1371 stores compared to the previous quarter. Among them, 857 were self-operated stores, and 514 were franchise stores.

The second quarter mainly saw a lag in the expansion pace of self-operated stores, perhaps due to the pressure on net cash flow from multiple quarters of supplier subsidies.

The growth of franchise stores is also lower compared to the first quarter, but the opening pace of franchisees depends not only on the payback period of franchisees (whether the industry is saturated) but also on whether franchisees have extra money on hand to use as a one-time investment after opening (related to the economic environment).

Previously, the company revealed that this year's store opening target is to reach 23,000 by the end of the year. As of July 18th, the company announced that the global number of stores has reached 20,000 (including 37 overseas), meaning that the remaining 5 and a half months need to continue to add 3,000 more stores.

Dolphin believes that with the double boost of peak season and new products, there is still a significant diversion effect on new stores, and Luckin may continue to slow down the pace of subsequent store openings. It is recommended to pay attention to whether the management will adjust the store opening target during the conference call.

1. Signs of Industry Saturation

(1) Same-store sales continue to decline:

Although store openings slowed down in Q2, the current pace of openings is not entirely rational, and the actual single-store model has been significantly affected.

In Q2, total same-store sales fell by 20.9%, with a 45% decline in revenue per single store. Despite the better year-on-year gross profit margin of self-operated stores, the operating profit margin has not returned to normal levels.

(2) Recovery of paying users may come from new product expansion:

Apart from the performance loss exceeding expectations in Q1, what alerted us the most was that while the pace of store expansion remained high, the number of paying users decreased month-on-month. If it is a growing industry with still significant penetration space, the off-peak season should not be a core reason.

In Q2, the number of paying users recovered, with the total number of paying users approaching 70 million within the quarter. In addition to the natural growth from peak season and new store openings, we believe it is closely related to the new light coffee products launched in the second quarter. Similar to fruit tea, light coffee is also suitable for the weather in the second quarter, to some extent helping Luckin break through from coffee users to other non-caffeine users.

Combining <1-2>, Dolphin's concerns about industry saturation have not been significantly reduced, and the trend of slowing down store openings is expected to continue.

2. Low possibility of short-term disarmament for Luckin: In the analysis at the beginning of the year ("Unstable Luckin, Indomitable KFC"), when Dolphin discussed the industry saturation period, with benign operations, the overall industry's store scale forecast was around 23,000. At that time, Luckin's store opening target was still to reach 25,000 by the end of the year, while KFC's target was 10,000 by the end of the yearIf Luckin Coffee reaches a stable state of 23,000 stores and can maintain healthy operations instead of closing stores after half a year, it means that most of the stores of Coffee Box will either close down or be transformed into Luckin Coffee stores. Despite many flaws (such as the Tea Cat and in-store shop models falling short of expectations) after six months of struggle, it is still difficult for Coffee Box to surrender in the short term.

Dolphin Jun still thinks from the perspective of franchisees. During the peak season when cup volume can be maintained at a high level, franchisees still hold onto fantasies and are reluctant to close stores. In reality, 70% of Coffee Box stores in the second quarter did not incur losses under Coffee Box's subsidies (30% were profitable, 40% broke even). Therefore, ideally, we can only expect a wave of store closures to occur during the off-season.

2. Income growth still relies on store expansion to drive

In the second quarter, Luckin Coffee's total revenue was 8.4 billion yuan, a year-on-year increase of 35.5%, slightly higher than the expectations of some institutions.

Looking into details, revenue growth from self-operated stores was 40%, mainly driven by the increase in the number of new stores. Franchise income growth continued to slow to 24.5%. Although the number of franchise stores increased by 89%, the year-on-year decrease in per-store turnover was significant (Dolphin Jun estimates -28%). The number of new stores opened also decreased year-on-year, affecting Luckin Coffee's growth in raw material sales, equipment sales, and store profit sharing.

3. Profit rebounds quickly with income

The first quarter saw losses due to the "off-season + subsidies," while the second quarter saw profits from the "peak season + reduced subsidies + new products."

On one hand, as the weather warms up, store cup volume and ASP naturally increase, and the introduction of new light coffee products with higher gross profit margins significantly improves the situation. However, at the store level, although the price increase has been implemented since the beginning of the year (reducing by 9.9 yuan), it cannot offset the drag of the off-season environment.

Currently, Luckin Coffee's 9.9 yuan strategy is mainly implemented in 1,000-2,000 stores that compete fiercely with Coffee Box, closely monitoring competitors and dynamically implementing promotions based on the performance of corresponding Coffee Box stores.

On the other hand, cost optimization is also reflected in the month-on-month improvement in product material cost ratio, depreciation and amortization ratio, and management expense ratio, which respectively demonstrate Luckin's advantages in supply chain management (lower material costs) and internal operational efficiency.

The operating profit margin at the level of self-operated stores has recovered to 21.5%, an increase of 15 percentage points month-on-month; other businesses of non-self-operated stores are also reducing losses.

The overall operating profit margin of the group reached 13%, achieving a net profit attributable to the parent of 871 million yuan, with a profit margin of 10.4%. Although it has not yet returned to the level of the same period last year, there has been a significant improvement compared to Q1.

Dolphin's "Luckin" series of articles:

Financial Report Season

April 30, 2024 conference call "Luckin: Q2 still faces challenges, with market share as the development goal (1Q24 conference call summary)"

April 30, 2024 financial report review "Luckin: Can it stand firm in the final leap?"

February 25, 2024 conference call "Luckin: The current strategic opportunity period for the coffee industry"

February 24, 2024 financial report review "Luckin: Darkest before the dawn"

November 2, 2023 conference call "The market is vast, but the competition is far from over (Luckin 3Q23 performance conference call summary)"2023 年 11 月 1 日财报点评"Rushing all the way, how many good days are left for Luckin Coffee?"

2023 年 8 月 3 日电话会"Rushing: Frequent launches of new products, aggressive store openings, and rising buyers (minutes)"

2023 年 8 月 3 日财报点评"Luckin Coffee: 'Ten Thousand Stores' Sprint, Leading the Market with Confidence"

2023 年 5 月 2 日电话会"Luckin Coffee: Expected to achieve the goal of ten thousand stores ahead of schedule"

2023 年 5 月 2 日财报点评"Luckin Coffee: Rapid expansion of stores, full-blooded comeback"

2023 年 3 月 3 日电话会"Realizing the goal of ten thousand stores in 23 years (Luckin Coffee performance meeting minutes)"

2023 年 3 月 2 日财报点评"New Luckin Coffee 'Reborn from the Ashes'"

In-depth

2024 年 1 月 16 日"Kudi, the unstable one, and the indomitable Luckin"

2023 年 3 月 14 日"Sword-wielding to cut out the tumor, Luckin wins the battle of redemption"

2023 年 2 月 14 日"Luckin Coffee (Part 1): Taking coffee to the countryside, can the explosive trend in county towns continue?"

Risk disclosure and statement of this article: Dolphin Research Disclaimer and General Disclosure

Cotti "not dead", Luckin "already old"?