Look to the Humble Donut for Big Value

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When analysts speak of thriving industries in which companies are generating large earnings growth, they are generally not referring to the donut market. However, the publicly traded makers of these fatty treats have been doing very well lately, as sweet-toothed consumers have apparently been indulging themselves en masse. Of the two main publicly traded donut companies, one has maintained a very reasonable valuation despite a spectacular run over the last twelve months. It appears as if Krispy Kreme Doughnuts (NYSE: KKD) offers a great deal of value at the moment, and is certainly cheaper than its prime competitor Dunkin’ Donuts.

Company overview

Unsurprisingly, Krispy Kreme Doughnuts makes and sells doughnuts (or donuts, as they are more commonly spelled), as well as being a wholesale distributor of these treats, beverages, and packaged sweets. The company operates 96 company stores and 635 franchise locations with 3,714 full-time employees. The stock has a market cap just under $1 billion, and has seen a huge 82% increase in price over the last twelve months.

Valuations and metrics

With a TTM P/E of 6.59, the stock is, in a word, cheap. The stock is without a doubt cheaper than that of a few of its competitors, Dunkin’ Brands Group (NASDAQ: DNKN) and Einstein Noah Restaurant Group (NASDAQ: BAGL), purveyor of tasty bagels. I’ve decided to include Einstein Noah in this comparison because, while they do not make donuts per se, do sell a bread product with a hole in the middle. Dunkin currently trades at a fairly inflated multiple of 39.72 times TTM earnings, and Einstein Noah trades at 19.59. On the other hand, Dunkin’s substantial operating margin of 38% easily beats out the other two, both with margins of under 10%. Looking at price to sales, Einstein Noah is clearly the cheapest of the three with only 0.58 versus Krispy Kreme’s 2.33 and Dunkin’s pricey 6.04.

Earnings

Krispy Kreme has been on a great run in terms of earnings over the last few years, although the most recent release was something of a disappointment. After posting some modest losses in the period between 2007 and 2009, the company meaningfully turned things around, growing annual EPS from $0.11 in 2011 to $0.31 in 2012. For fiscal 2013, the company has beaten analyst expectations for the first three quarters, whereas they had two beats and two meets in 2012. Looking ahead, the 3-5 year expected EPS growth rate is an impressive 49.7%, easily outpacing the industry average of 17.8%.

For the Q4 2013 report released on Thursday after hours, the company posted EPS of $0.09, which missed by $0.03, but beat slightly on revenue. The news sent the stock tumbling in after-hours trading. For the quarter, revenue was up 7% to $109 million, and income was up 35% to $7.2 million. Looking ahead, management expects EPS of between $0.53 and $0.57 for fiscal 2014.

Regarding the competition, Einstein Noah posted fairly decent figures in 2007-2009, but they haven’t been growing earnings as impressively as Krispy Kreme in the period since then. From 2010 to 2012 they grew earnings from $0.68 to $0.95, and the expected 3-5 year growth rate of -3.8% pales in comparison. Dunkin has posted pretty solid growth over the last few years, but I’m not too bullish on them due to their high valuation.

Bottom line

All in all, Krispy Kreme appears to be a severely undervalued food company. With solid earnings that have been on the increase as of late, the company has turned things around, and expectations are that these will increase even more over the next few years. In any case, the stock is trading at lower multiples than that of some of the competition, and certainly lower than the overall industry. If you’re looking for great value in a simple product, this is it. As the stock has had such a good run recently, however, investors would probably be well advised to wait for a pullback before getting in.


Daniel James has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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