After Losing Some Altitude, Can Krispy Kreme Regain Its Mojo?

Shares of Krispy Kreme Doughnuts have been stuck in reverse in 2014, hurt by less than ideal financial results in its latest fiscal quarter. Is it time to buy in?

Jul 3, 2014 at 10:00AM

Shareholders in Krispy Kreme Doughnuts (NYSE:KKD) have enjoyed "tasty" returns over the past five years, with the company's stock price up more than 400%, thanks to gradually improving profitability, as well as a sizable expansion of its store base, part of its bid to keep pace with growing competitors, like Dunkin' Brands (NASDAQ:DNKN) and Starbucks (NASDAQ:SBUX)

But 2014 has been a more difficult campaign for Krispy Kreme, due to worse than expected profitability in its latest financial update that led to a subsequent, double-digit sell-off in its share price. The company was particularly hurt by a slowdown in comparable store sales growth in its domestic operations, which limited growth in sales of supplies to its associated franchisees, Krispy Kreme's largest source of profit. After a price haircut, though, is Krispy Kreme a good bet?

What's the value?
Krispy Kreme is one of the country's largest doughnut chains, operating a network of roughly 260 domestic stores, as well as almost 600 stores in select international markets, like Saudi Arabia and South Korea. While Krispy Kreme only recently started growing its domestic base of stores again after a multiyear hiatus, it has seemingly never missed a beat in its international segment, consistently growing the number of locations year after year. The net result for Krispy Kreme has been a solidly upward trajectory for its top line, up 32.8% over the past four fiscal years.

In its latest fiscal year, it was more of the same for Krispy Kreme, evidenced by a comparable store sales increase and a double-digit expansion of its store base that combined to produce a 5.6% overall sales gain for the company. More importantly, Krispy Kreme took advantage of higher average prices, partially due to a greater focus on its newer, premium priced beverage offerings, to generate a strong adjusted operating profit performance during the period, up 26.1%. The higher profit led to better operating cash flow, fueling the company's various growth initiatives, including the further development of a small-format factory-store concept.

Looking into the crystal ball
Despite falling a bit short in its latest fiscal quarter, Krispy Kreme did manage to report increases in both revenues and adjusted operating income. On the downside, though, the company's customer traffic volumes declined during the period, indicating that future comparable store sales growth may be harder to come by.

Part of Krispy Kreme's problem is the like-minded growth ambitions of the company's major competitors, including Dunkin' Brands. The owner of the Dunkin' Donuts brand has continued to be in expansion mode lately, adding roughly 5% more stores to its domestic store base of over 7,600 stores in its latest fiscal year. The company's existing store base is also performing well, reporting a 3.4% comparable store sales increase during the period, helped by a menu evolution that has focused on higher priced beverage and sandwich options. The net result for Dunkin' Brands was higher operating income, funding its growth across the country, including a major development push in California.

Likewise, Starbucks continues to grow fast, adding stores in all of its major geographies, including a roughly 6% addition to the store base in its Americas segment during the current fiscal year. More importantly, the company has been aggressively expanding its offerings in the food area as it tries to lower its dependence on coffee sales, approximately three-fourths of its total revenues, highlighted by its recent introduction of an assortment of new breakfast sandwiches. Starbucks' goal is undoubtedly to give customers less of an incentive to go anywhere else for their impulse food purchases -- like to Krispy Kreme's stores.

The bottom line
Krispy Kreme is certainly cheaper than it was at the start of 2014, after a double-digit stock price decline. That being said, the company is still priced at an above-market P/E multiple of roughly 31, a pricey level given Krispy Kreme's slowdown in profit growth in its latest fiscal quarter, not to mention its reduced profit outlook for the current fiscal year. As such, investors should buy the doughnuts, but probably not the stock.

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Robert Hanley owns shares of Krispy Kreme Doughnuts. The Motley Fool recommends Starbucks. The Motley Fool owns shares of Starbucks. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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