Staying Cool About Krispy Kreme

Uh-oh; is there more bad news for Krispy Kreme Doughnuts (NYSE: KKD)? Some investors apparently feared the worst today when the company revealed plans to restate earnings for the last three quarters of 2004. In addition, the company said it may default on its credit facility, and many news agencies reported word that the company is being sued for padding sales.

In the lawsuit, several former employees allege that Krispy Kreme had doubled its shipments to wholesale customers in order to make quarterly sales targets four different times. The lawsuit alleges that management knew sales were slowing by January 2003 but glossed it over until Krispy Kreme reported that infamous first quarterly loss last spring.

The restatement is seen reducing Krispy Kreme's fiscal 2004 net income by between approximately $3.8 million and $4.9 million, or $0.07 per share to $0.08 per share, and the company said that it could default on its credit facility, under which it has borrowed $90.9 million.

Today's rumblings, of course, brought investors' worst fears to light. After all, there has been no shortage of bearishness on this stock lately. (Read Bill Mann's take on the subject: Krispy Kreme's Fair Value: Zero.)

Given the news and the consequent stock decrease, I was inspired to talk to David Gardner about Krispy Kreme, since it is one of his recommendations for Motley Fool Stock Advisor (and one of his few recommendations that has gone south).

David pointed out that today's news is really a reflection of investors' worst fears, but none of these developments are particularly surprising (or even really news) given developments since last May.

And while many investors are obviously tempted to sell, David cautioned against selling at what may be a bottom. He is disappointed with continued implications of management's incompetence (or, if lawsuit allegations turn out to be true, possibly criminal), but he also pointed out, if the worst is proven about the company's management, it's inevitable that ousting and replacement is imminent, which would likely be good news.

Regardless, David pointed out that Krispy Kreme is still a strong consumer product. Dietary concerns are not going to destroy its almighty doughnut; McDonald's (NYSE: MCD) is the poster child for not falling prey for obesity concerns. Meanwhile, the low-carb craze has been definitely showing signs of weakening over recent months.  

The developments, of course, also weave a cautionary tale that investors should heed: that it's always good to diversify portfolios -- in layman's terms, avoid putting all eggs in one basket -- just in case something unforeseen happens. In Krispy Kreme's case, before last May, there was little reason to suspect the company's management of negative adjectives running the gamut from incompetent to corrupt.

Days like today are of course difficult for long-term investors. Keeping a cool head can be the most difficult thing in the world; while it's likely not advisable to sink new money in the stock (unless one is steeled for the risk inherent in such a move), it's not a good idea to sell when sentiment dips as low as it can get.

For more on Krispy Kreme, read the following Foolish content:

• Is Krispy Kreme in denial?
• Krispy Kreme clams up.
• Is Krispy Kreme's fair value zero?

Krispy Kreme is one of the few Motley Fool Stock Advisor picks to falter. To find out other stock picks, click here to try the service risk-free for six months.  

Alyce Lomax does not own shares of any of the companies mentioned.