This Kreme Is a Rising Star

Robert 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) looks like it is once again on the right track with rising international store counts in places like India and Russia and a sharply higher stock price over the past twelve months.  Despite heavy competition in the quick serve category for the morning crowd, especially from Dunkin’ Brands (NASDAQ: DNKN) and Starbucks (NASDAQ: SBUX), the company has strong brand loyalty to its signature doughnuts.  It has also found its way to better profits with smaller stores that expand its reach into less populated areas.  So, does this story still have legs?

What’s the value?

Despite a history that pre-dates its larger competitors, Krispy Kreme was primarily a regional operator, clustered in the U.S. southeast area, until its initial public offering in 2000 brought name recognition and a major national expansion push.  Its subsequent fast growth led management to take on debt to buy out franchisees, a bad strategy that almost sank the company when overall sales growth tapered off.  Fortunately, Krispy Kreme survived thanks to a strong international base of stores that has continued to grow each year, with operations currently in 22 countries.

In its latest fiscal year, Krispy Kreme reported strong financial results, with increases in revenues and operating income of 8.1% and 47.3%, respectively, versus the prior year.  Its sales growth benefited from rising comparable store sales, up 5.5% for the period, as well as the addition of stores in new and existing international markets.  More importantly, the company’s gross and operating margins increased as it successfully pushed through price increases in both retail and wholesale channels.

Butting heads with the coffee giants

Of course, Krispy Kreme is a bit of a one-act wonder, as doughnuts constitute roughly 88% of its overall sales.  Management seems to understand the need to diversify its product line, though, with recent introductions of new coffee blends and its Chiller line of frozen beverages.  However, the company's desire to increase its revenues from coffee sales puts it directly in the headlights of the growth-oriented coffee chains.

One of those major competitors is Dunkin’ Brands, which has built a formidable global operation with almost 18,000 locations in 55 countries around the world.  It utilizes the franchise model almost exclusively, which has allowed it to grow very fast, almost doubling its store count over the past ten years.  In addition, the company has been pushing beyond its trademark doughnut and coffee offerings with greater food options, like breakfast burritos and bagel sandwiches.

In FY2013, Dunkin’ Brands has generated solid financial results, with increases in revenues and adjusted operating income of 6.0% and 35.3%, respectively, compared to the prior-year period.  The company benefited from strong comparable store sales in its domestic Dunkin’ Donuts and international Baskin-Robbins segments, as well as the addition of 700 stores around the world.  In addition, Dunkin’ Brands continues to generate growth in the wholesale market, with a leading position for its packaged and single-serve products.

Naturally, the biggest competitive threat is Starbucks, the largest coffeehouse chain that gets bigger and stronger every year, with a current base of over 19,000 stores around the world.  While the company continues to place its stores on every high-trafficked corner in the U.S., it has set its sights on similarly dominating the coffee scene in high-growth Asian markets.  Starbucks is also looking to enhance its standing among the tea-drinking population, purchasing the Teavana chain of tea shops for roughly $616 million in 2012.

In FY2013, Starbucks has continued to report solid financial results, with increases in revenues and adjusted operating income of 11.7% and 21.9%, respectively, versus the prior-year period.  Its top-line growth was aided by rising same store sales, up 8% for the period, as well as the opening of over 1,500 new locations around the globe.  In addition, the company has been a beneficiary of falling coffee commodity costs, which has provided a strong positive bump to its bottom line.  Looking ahead, Starbucks is adding a greater variety of food items to its store network, a rare sore spot among customers, which should eliminate an advantage previously enjoyed by its competitors.

The bottom line

Krispy Kreme is on the rise, though it still needs to lower its business risk by increasing the diversity of its product offerings.  Major competitors Dunkin’ Brands and Starbucks continue to upgrade their own product offerings and will likely be the major competition in Krispy Kreme’s expansion plans.  However, consumers’ love of morning coffee and doughnuts seems to have no signs of slowing down, despite occasional price increases, providing room for all three competitors to pursue their growth ambitions. They all belong on investors’ watchlists.

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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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