The Global Donut

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Everyone's favourite donut company, Krispy Kreme Doughnuts (NYSE: KKD), has been getting a little sweeter these past few weeks. The stock was the darling of bulls from 2000 through 2002 when tech stocks were crumbling because of the internet bubble, but the latter part of the 'noughties' wasn't kind and the stock plummeted from a peak of $49.74 in 2003 to $1 a share in 2009. A combination of lost market share to Dunkin' Donuts (NASDAQ: DNKN), new products from competitors McDonald's (NYSE: MCD) and Starbucks (NASDAQ: SBUX), and an overly aggressive expansion strategy helped trigger the rout. An accounting scandal in 2004 was the ugly glaze on top of the loss in fundamentals.  A successful restructuring process in 2005 was undone by the credit crisis and it was then that the stock reached its $1 low.

<img src="http://media.ycharts.com/charts/09f87eb5e8453adaac54577c219be944.png" />

KKD data by YCharts

From the fateful low in 2009 the stock has risen tenfold. It reported break-even results in 2010, which helped fuel the rally, and the stock peak at  $10 in May 2011 was driven by Q1 earnings, which saw significant increases in revenues, net income and cash. Since the May 2011 peak the stock subsequently mellowed, finding buyers at around $6, but struggling to get past $8.50.  Ironically, Q1 earnings in the current year beat comparable earnings last year by a penny and were well ahead of analyst estimates, but investors didn't take the bait.  Net income was down $3.2 million on the comparable quarter, although a 'valuation allowance on deferred tax assets' was cited as the reason, effectively muddying the comparison. On the positive front, cash provided by operating activities doubled to $10 million. 

It wasn't until Q2 earnings that investors paid attention. By then the company had completed its share repurchase program, retiring 3.1 million shares at an average price of $6.42 (reducing the float by 5%).  Same store sales rose by 5.4%, its fifteenth consecutive quarterly increase. This fell in line with competitors; Dunkin' Donuts reported a 5.5% same sale growth increase for the first six months, Starbucks posted a 7% increase, while McDonalds' same store sales were down 0.1%.  So while its competitors may have an edge on menu and beverage offerings, it has been able to keep pace through optimizations elsewhere in the business, e.g. closing unprofitable stores (240).  

The closing of stores in the U.S. was countered by international growth.  The chain has 390 international franchises, over double its domestic exposure, with plans to bring that figure to 900 by 2017.  Revenues from its international sector rose 8%, exceeding the 3% growth from its domestic sector.  But this was countered by a whopping 10% loss in international same store sales; the company warned of cannibalization - the same issue which troubled its domestic operations during the 'noughties' - so if it's to reach its international expansion goals it will have to tread carefully.

As a turnaround story with a well established brand, it has been muted as a potential takeover candidate.  From a valuation standpoint, it has a P/E of 3.3 which is far less than its competitors (Dunkin Donuts at 73.3, Starbucks at 28.4 and McDonalds at 17.0), so as an accumulator stock it fits the bill nicely. Where it loses appeal is its focus almost exclusively on the donut business. It would appear the company has opted to drive growth through international expansion and not beef up its menu options. If it can avoid the pitfalls which got the company into trouble the first time around, it may succeed and perhaps attract a suitor in the process.  


fallond owns shares of McDonald's. The Motley Fool owns shares of McDonald's and Starbucks and is short Starbucks. Motley Fool newsletter services recommend McDonald's and 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.If you have questions about this post or the Fool’s blog network, click here for information.

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