Can Krispy Kreme Become a Doughnut King?

Krispy Kreme Doughnuts recently reported solid fourth-quarter and year-end results, but the company still faces stiff competition.

Mar 21, 2014 at 6:00PM

Krispy Kreme Doughnuts' (NYSE:KKD) fourth-quarter and year-end numbers continued baking on the heels of 20 prior quarters of positive same-store sales growth. But the question remains whether the doughnut maker can become a doughnut king.

Krispy Kreme faces a number of challenges in the coffee-chain sector with competitors like Dunkin' Brands (NASDAQ:DNKN) and Starbucks (NASDAQ:SBUX). The first is the fact that these coffee stores have a greater share of the retail coffee-chain market. Moreover, Dunkin Donuts has moved well beyond serving jelly-filled delights in order to compete with Starbucks' broader menu, which was beefed up by the acquisition of La Boulange last year.

Krispy Kreme's financials at a glance
In the fourth quarter, revenue increased 3.3% to $112.7 million from $109.1 million as company same-store sales rose 1.6%, the 21st consecutive quarterly increase. And Krispy Kreme management says these figures would have been about 1% higher had it not been for the harsh winter weather in a number of key markets.

The company's adjusted net income really brought the yeast, as it rose by 37% to $8.3 million, or $0.12 per share. This compares to $6.1 million, or $0.09 per share, in the year-ago period. Krispy Kreme also repurchased $20.5 million worth of common stock in fiscal 2014, leaving $55.7 million in cash on hand -- and that's a lot of dough.

Challenges to future growth
While Krispy Kreme customers rave about the company's sweet treats, the food police contend doughnuts are bad for your health. If this mind-set gains traction, then it could have an adverse impact on the business' future growth.

However, Krispy Kreme plans to expand its brand by capturing market share with increased beverage sales. And CEO James H. Morgan anticipates year-over-year growth in adjusted earnings per share of 20% to 30%.

Starbucks' and Dunkin' Brands' expansion plans
In the meantime, Krispy Kreme's biggest challenge is competition from Starbucks and Dunkin' Brands. And these companies are continuing to grow revenue and earnings by store expansion.

In 2013, Starbucks paired up with Target to open 150 new coffee outlets, one in almost every new Target store opened during last fall's push into Canada.

For its part, Dunkin' Brands has long been an established franchise outfit. The company's brand also includes Baskin-Robbins ice cream stores in its 10,500-shop empire. Dunkin's franchising operation allows stores to readily pop up with comparatively low start-up costs.

The company is also taking its brand to the United Kingdom in a strategic alliance with two London-based groups. The five-year plan in play calls for Dunkin' to develop 150 stores in the United Kingdom.

The last cream puff
Krispy Kreme has indeed posted very solid numbers showing continued revenue and earnings growth. And this has been an ongoing pattern for 21 consecutive quarters. But the question remains: How far can the company take this, and will investors will go along for the ride in the long run?

That said, Krispy Kreme's guidance for the rest of its fiscal year calls for continued earnings growth. Future stock repurchases will also boost those earnings figures. And the company has enough dough in the shop to contemplate more buybacks.

Further on up the road, in order to compete effectively with Dunkin' Brands and Starbucks, Krispy Kreme will need to consider some changes: for instance, broadening its menu and offering customers a healthier line of offerings -- perhaps whole-grain and organic items and other light, not-so-sweet snacks.

Of course, in my opinion Krispy Kreme's customers should have no fear of the food police and continue enjoying one of the doughnut shops heavenly glazed treats; after all, life is brief. In sum, Krispy Kreme should provide investors with opportunities in the short term.

Ultimately, however, Dunkin' Brands and Starbucks are probably better choices in this sector for investors with a long-term view. Even though Starbucks lowered its 2014 guidance in its last financial report, the company intends to open new stores and leave a bigger footprint on the Web.

In short, the leading coffee shops have plans for future growth and track records of solid revenue and earnings growth. And the diversity of each chain's menu presents Krispy Kreme with a big challenge to meet.

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