Saving Krispy's Kreme

We're dueling for doughnuts here at Fool.com. Recently, Bill Mannsaid Krispy Kreme was cooked. Now Rick Munarriz counters, offering some suggestions for how to right this doughnut ship. Fools duel, and you win. Let us know what you think on the Krispy Kremediscussion board.

So is this the way it's going to be? A month ago, if I had walked into a meeting with a box of Krispy Kreme (NYSE: KKD  ) hot glazed doughnuts, I would have been put on a pedestal. Nowadays, I would be catapulted out the window.

Ever since the company announced that it would be posting lower earnings this year it seems as if everybody is dusting off their wordplay to write about a company with a "hole" in its business model or losing "dough" on the investment.

I have no beef with folks like Herb Greenberg and our own Bill Mann who were publicly bearish well before the stock's collapse earlier this month. They have every right to gloat, if they choose to do so. However, the masses coming out of the woodwork to pick out flaws in Krispy Kreme these days is a laughable sight.

I have no excuses. I've admired the company for ages and thought I was getting a bargain when I bought a round lot of 100 shares two months ago at a little more than $35 a stub. Now $1,500 poorer in my Roth IRA account, I'm hurting -- but I'm not selling.

I'm not purchasing, either. That's significant because as a contrarian my gut instinct at the sight of an implosion is to buy rather than bolt. I'm opting not to throw new money at the situation because I can recognize that the company has some legitimate problems at the moment. Krispy Kreme's shortcomings may be overblown, but I think the real issue here is that its malaise is being misdiagnosed.

Glazed and confused
Some people have labeled Krispy Kreme as faddish -- a flash in the frying pan. It's an amusing notion when one considers that the company has been serving up its signature treats since 1937.

The concept's proliferation has also taken the blame. Once a regional phenomenon, it was able to parlay its IPO four years ago into a platform to fuel rapid-fire expansion. The argument goes: Once its doughnut shops began to line the country and its retail distribution found the packaged delicacies selling at a supermarket near you, folks just got bored eating them.

That argument would hold up well if it weren't for Starbucks (Nasdaq: SBUX  ) . Here's a company that has grown its outlet empire significantly faster while filling grocery stores with everything from coffee beans to ice cream to refrigerated Frappuccinos. The premium java specialist's push into the mainstream certainly hasn't hurt the bottom line.

The more popular school of thought right now is that the low-carb movement did Krispy Kreme in. I'm sure that the dieting movement has played a part in the company's stumble, but analyze this a little closer and you will see some flaws in that theory. Carb heavies like orange juice makers and pasta restaurants have been wincing since last year. The company that was singled out last year in our Motley Fool Stock Advisor newsletter had no problem growing its comps as folks spent the holidays reading up on the Atkins-approved edibles and battling New Year resolutions through the first quarter of 2004.

You also have its largest rival, Allied Domecq's (NYSE: AED  ) Dunkin' Donuts, reporting that everything is just peachy in its world. Put it all together and none of the reasons gel just right. That's important because you can't drum up the right answer when you're asking the wrong question.

Kreme puff
Some of Greenberg's knocks on Krispy Kreme weren't fair. He argued that its 2002 acquisition of Montana Mills signaled an entity running out of organic real estate, but I don't see it that way. If anything, it was Dunkin' Donuts teaming up with Baskin-Robbins ice cream and Togo's sandwiches that has helped it remain more of an all-weather foodstuffs provider.

Eateries have always made a habit of scooping up promising concepts while they still had plenty of room for expansion. Outback Steakhouse (NYSE: OSI  ) partnered with Carrabba's 11 years ago and it certainly didn't slow the namesake concept. So, I won't fault Krispy Kreme's vision for buying a chain of bakeries well before the popularity of Atkins and South Beach diets had folks swearing off doughy eats. That's just revisionist history at this point.

After doing my best to deflect most of the shots being hailed at Krispy Kreme, does that mean I think the company is flawless? Of course not. I can see the rotund chalk marks of a body that was once livelier. Earnings don't fall without a reason.

I will try to give this column a constructive slant by proposing three ways for Krispy Kreme to get back into a good groove. Along the way, see if you can pick up on where I think the company really went wrong.

1. Wake up and smell the coffee. If you want to take Krispy Kreme to task, fault it for not taking a stronger position in marketing premium coffees. Starbucks and Dunkin' Donuts have continued to thrive because they realized that caffeine is more addictive than sugar. Naturally, Krispy Kreme stores will have no problem pouring you a hot cup of joe -- or even a more potent shot of espresso or a refreshing frozen blend -- but it's got to do a better job of letting the world know that it's more than just a fluffy one-trick pony. Coffee sales make up just 10% of the company's sales. That's not enough.

Putting the cruel in cruller, Krispy Kreme may have been clever to incorporate some of its doughnut flavors into its beverage blends. If it really needs to revitalize its concept, however, it needs to start with this: Make the java as distinctive a stand-alone product as its signature delicacies.

2. Bend without breaking. When Krispy Kreme announced that it would be rolling out a low-fat doughnut with a low count of net carbs later this year, it was right for a lot of people -- including our own Alyce Lomax -- to take a cynical view. Krispy Kreme's brand is richly admired, but it is also synonymous with decadence. You don't want to dilute that by sending mixed messages. But history is kind on that front. Coca-Cola (NYSE: KO  ) is certainly a stronger company because of Diet Coke.

So, get these lighter doughnuts out -- and get them out quickly. However, make sure that the distinction isn't drawn in gray sand. A company like Starbucks is able to succeed at peddling its cold brews anywhere because a Frappuccino is a Frappuccino. Resist the temptation to name these babies Krispy Kreme Lites. Position them as their own brand. Karb Kounters. Diet Delites. Dough-Nots. In the long run, differentiation will mean everything.

3. Retell retail. While I have always enjoyed the convenience of Krispy Kreme products at my local supermarket, quality control is a problem. Going through a few stale concoctions sometimes threatens to disconnect me from remembering the gluttonous pleasure of biting into one that is freshly made.

Maybe it is time to backtrack in retail distribution to give the namesake outlets a fighting chance to regain their mystique. While the Krispy Kreme name is still gold, retreat and repackage the Krispy Kreme that folks see at the grocer. Team up with a frozen novelty maker to put out Krispy Kreme ice cream flavors. From cereal bars to breakfast cereals -- from brownie mixes to kettle corn icing -- help out the cause on both fronts by making every Krispy Kreme experience unique.

The future? If you let it, it can be as bright as a blazing "Hot Doughnuts Now" sign.

Next -- Read Bill Mann's bearish take: Krispy Kremed.

Rick Aristotle Munarriz thinks that a great thing in moderation is better than a good thing in abundance. That's why he only eats so many Krispy Kreme doughnuts at a time. He does own shares in Krispy Kreme. Rick's stock holdings can be viewed online, as can the Fool's disclosure policy.


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