Save Your Doughnuts for Winter

Declan is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Krispy Kreme Doughnuts (NYSE: KKD) has been a standout performer in the stocks I have covered.

The stock first featured in September, when it traded at $7.47, and looked an attractive takeover proposition with a then Price/Earnings (P/E) ratio at 3.3. It followed with a solid run to bring it into the teens as broad market strength helped carry it higher. By February it had booked a 50% gain, and I then suggested selling some covered calls to generate some income from the position. By May I had again suggested taking profit with those calls about to close flat. So the late burst in May which drove the stock into the upper teens was a real surprise, given P/Es were already looking rich in the forties (although forward P/Es were a more attractive 19) prior to this burst.

The stock is still holding in the upper teens, but an attempt at challenging $20 looks to have run out of steam. Not surprisingly, the once cheap P/E of 3.3 is now looking heated in the fifties, with a forward P/E that has crept into the mid-twenties.

Fair value to peers

Where it was once undervalued against its peers, it's now running about par on future earnings: Dunkin's Brands Group (NASDAQ: DNKN) has a P/E in the forties, but ironically has a near identical forward P/E to Krispy Kreme Doughnuts; the more diversified Starbucks (NASDAQ: SBUX) has a P/E in the thirties, but a forward P/E that is slightly above the two doughnut companies'. In this respect it has lost some of its edge. Of the three stocks Krispy Kreme is the only one not to pay a dividend, although at little over 1% for both Starbucks and Dunkin's Brands they are not going to be setting an income fund alight.

Dunkin' for summer

Not surprisingly, the Krispy Kreme surge was triggered by blow-out earnings, driven by a 11% rise in same store sales and increased guidance. And for the same reasons in May which had me wary, these growth figures can't last forever, or support the current P/E ratio over the long haul. AnnaLisa Kraft reported on the success of Krispy Kreme's social media campaign during National Doughnut Day against its larger doughnut rival, but also noted how the summer season plays more into Dunkin's Brands diversified brand strength, which will make it harder for Krispy Kreme heading into the next couple of quarters.

Respect the heavyweight

As the old timer, Starbucks is well insulated from the doughnut wars. However, it does offer a good barometer as to how a mature Krispy Kreme or indeed Dunkin's Brand should be for investors. Starbucks is still able to deliver double digit revenue growth, and recently reported global comp store sales growth of 6%; and 7% in the U.S. Starbucks has also demonstrated the strength of individual menu items in generating comp sale growth: the jump in U.S. same store sales was largely thanks to two featured beverages, Vanilla Spice Latte and Hazelnut Macchiato, with paninis and its Bistro box making up a good chunk of the rest of it. The acquisition of Teavana adds another feather to Starbuck's cap, and this side of the business is only something Krispy Kreme can aspire too - although it's better suited as the acquisition, and not the acquirer: Starbuck's existing cash position could easily consume all of Krispy Kreme and still have nearly $600 million left over in the bank!

Overseas opportunity

Further good news for both Krispy Kreme and Dunkin's Brands has been the strong performance of new Starbucks' stores in the U.S., some of which have been "the best performing stores in the 42-year history of the Company". So there is plenty of room for domestic expansion. Starbucks is aggressively expanding in developing markets like Vietnam, Philippines and Indonesia, including Eastern Europe and the Middle East. Dunkin' has focused more on its Baskin-Robbins brand overseas, but has found the domestic market more productive. While Krispy Kreme has European, Central and South America in its expansion plans, including looking at new markets in Taiwan and Moscow.

Summary

With Krispy Kreme, the goal should be to obtain consistent levels of same store growth. Double digit same store growth figures only bring disappointment when they fall to (likely still to be good) single digits. From a price per earnings standpoint, Krispy Kreme is looking rich, but would offer value with a P/E in the mid-30s - comparable to Starbuck's - which as a mature company is considerably further along its growth cycle. The summer season may see Krispy Kreme lose out to Dunkin's Brands, but this may leave the stock nicely primed for a move higher once the colder, sugar-fix months of winter roll in.


Declan Fallon has no position in any stocks mentioned. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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