Ordinarily, I'd start this duel off by analyzing Krispy Kreme Doughnuts' (NYSE:KKD) financial statements. Unfortunately, this is not possible as the company has had to delay its reporting of fiscal-year 2005 earnings as well as first-quarter 2006 results in order to restate earnings for earlier years.
It will also not be possible to consider the company's business plan. Its new management team, led by restructuring expert Stephen Cooper, has yet to announce its turnaround strategy. There is additional uncertainty surrounding the company due to an ongoing SEC investigation into accounting violations and numerous lawsuits relating to accusations of share price manipulation. Investing in Krispy Kreme in the current environment is like whitewater rafting down the Colorado River with a blindfold on. The next sign of danger is likely to be the sound of your forehead hitting a rock.
What we do know about Krispy Kreme's phantom financial statements is worrying. The company has tentatively announced that systemwide sales decreased by 13% in FY 2005 and by 20% in the fourth quarter of that year. For Q1 of 2006, systemwide sales fell by another 21%.
Of all the pressing problems facing this company -- the lawsuits, the financial irregularities, the executive team reshuffling -- it is the decline in sales and resulting decline in cash flows that is most fundamental. Consumers appear to be eating fewer doughnuts. Perhaps Krispy Kreme should borrow from the successful "time to make the doughnuts campaign" that Dunkin' Donuts, a division of Allied Domecq, ran. How about "time to eat the doughnuts"?
Having grown up in America's doughnut belt in Central Massachusetts, I'm tempted to offer a hypothesis or two as to why Krispy Kremes have declined in popularity in just a few short years. But such ruminations would not be entirely helpful and most definitely wouldn't be scientific. The question before us is not whether the company can make money in a falling demand environment -- I actually think it can. Rather, the key question is this: Is now a good time to invest in Krispy Kreme considering what we don't know about the company?
Let's begin by considering a rosy scenario that was laid out by one of our Foolish analysts back in March 2005. According to this view, Krispy Kreme might be able to return to profitability in 2007 if it is able to close unprofitable stores and pay down its sizeable debt. If all goes according to plan, then Krispy Kreme might be a value play at its current price.
Another Fool pointed out the numerous flaws in the rosy scenario a day later. He noted that putting franchises out to pasture will only worsen the company's balance sheet. He also pointed out that its debt is mostly bank debt, which is callable now that the company has failed to meet its reporting deadlines. The writer concluded that under the worst-case scenario, this company has a fair value of zero.
So which of the two scenarios is most likely? We just don't know. What's it called when you put money down on an outcome that is so uncertain? Oh, right, gambling. Now, there's nothing wrong with gambling, but if that's your thing, why not do it right? Fly to Vegas and take in the Wayne Newton show after a night on the tables or slots. When you return home after losing all your cash, at least you'll have that memory of when "Mr. Las Vegas" belted out "Danke Shoen" in his encore.
Krispy Kreme is a recommendation of our Motley Fool Stock Advisor newsletter service. Since its 2002 debut, the average pick has tripled the return of the S&P 500. But the Duel doesn't end here. Check out the Bull argument and the Bull and Bear rebuttals, then cast your vote for the winner.
John Reeves does not own shares in any of the companies mentioned in the article. He did, however, eat two doughnuts a week, every week, for the first 18 years of his life. This comes out to approximately 1,850 doughnuts. Click here for The Motley Fool's disclosure policy.
