3 Reasons Not to Give Up on Krispy Kreme

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

If you're an investor in Krispy Kreme (NYSE: KKD) you may not have liked what you saw recently with a considerable sell-off.  Shares dropped, for seemingly no reason, nearly 10%.  Perhaps Krispy Kreme was a speculative investment for you.  After all, they have had profitability problems in the past, and a considerable amount of lingering debt.  If you are thinking that it's just too risky and this recent drop proves it, let's sit down and calmly look at 3 reasons not to give up on Krispy Kreme just yet.

The Sell-off

I said the sell-off was sparked by seemingly nothing.  What I meant by that was Krispy Kreme did not release earnings, or submit a statement to the press that would have put the business in question.  These are the normal things that spark large stock dumps.  None of these things happened.  But I don't want you to think that absolutely nothing happened at all.  In reality, someone sold 134,565 shares recently.

Some are calling this insider trading, but really that's a little misleading.  This sale was from an investing company in Kuwait called Mohamed Abdulmohsin Al Kharafi & Sons.  This company still holds a considerable stake (about 10%) in KK.  

There are two good takeaways from this:

  1. It wasn't management selling
  2. Mohamed Abdulmohsin still believes in Krispy Kreme enough to hold a 10% stake.

While 134,565 shares might be a large number, I think that we must keep in mind that Mohamed Abdulmohsin is an investment company.  It makes sense that they would sell some shares every now and then.

The Future Growth

There are some growth prospects for Krispy Kreme in the United States, but the growth thrust right now is international.  Currently, they operate about 390 shops internationally.  In the last quarter they opened up 24 new locations.  That growth came from several countries, but the push right now is in new countries India and Russia.  Although it's anyone's guess, management has also hinted that other new international markets are in the works.

The statement that really caught my eye from the most recent earnings conference call was in reference to the 24 new locations for the quarter.  "All of these actions will bring us closer to the goal of 900 international store locations before the end of fiscal 2017."  If we are evaluating Krispy Kreme as an investment, we should be looking 3-5 years out.  This statement helps us do that by revealing to us their 5 year goal.  Basically, they are expecting to nearly double the business in 5 years.

The Price to Earnings

Nowhere on Wall Street are you going to find a company working on a double, trading for as cheap as Krispy Kreme Doughnuts.  

<table> <tbody> <tr> <td><strong>Company</strong></td> <td><strong>P/E Ratio</strong></td> <td><strong>Future P/E</strong></td> </tr> <tr> <td>Krispy Kreme</td> <td>3.10</td> <td>13.67*</td> </tr> <tr> <td><strong>Dunkin' Brands</strong> <span class="ticker" data-id="249989">(NASDAQ: <a href="http://caps.fool.com/Ticker/DNKN.aspx">DNKN</a>)</span></td> <td>76.67</td> <td>20.11</td> </tr> <tr> <td><strong>Tim Horton's</strong> <span class="ticker" data-id="208382">(NYSE: <a href="http://caps.fool.com/Ticker/THI.aspx">THI</a>)</span></td> <td>18.06</td> <td>15.37</td> </tr> <tr> <td><strong>Einstein Noah</strong> <span class="ticker" data-id="210292">(NASDAQ: <a href="http://caps.fool.com/Ticker/BAGL.aspx">BAGL</a>)</span></td> <td>16.49</td> <td>12.96</td> </tr> <tr> <td><strong>Starbucks</strong> <span class="ticker" data-id="205374">(NASDAQ: <a href="http://caps.fool.com/Ticker/SBUX.aspx">SBUX</a>)</span></td> <td>28.41</td> <td>19.49</td> </tr> </tbody> </table>

How many times have you seen a p/e ratio of 3?  Not very often.  It's a very good number.  But then the future p/e for KK seems counter-intuitive.  Let's just say that as this company increases in profitability, taxes and debt will eat into some of those gains.  That's why they can be on the growth spurt that they're on and have their price to earnings go in the opposite direction.  It's not exciting to see the statistic go the "wrong way" but 13 is still a really cheap valuation as well.

The only other company who competes with Krispy Kreme in rapid growth like this is Starbucks.  Starbucks continues their global expansion at the speed of light.  But then when you look at Starbucks' numbers, it's more in line with what you would expect from that kind of growth.

Conclusion

I don't think that now is the time to quit on Krispy Kreme.  In fact, right now may be a really good time to get in.  This company has had problems in the past, but they are working really hard to overcome their challenges, grow responsibly, and deliver for their shareholders.  As the next few years play out, I think you'll see this company shake off its tough past and establish itself as a global brand.


thequast has no positions in the stocks mentioned above. The Motley Fool owns shares of Starbucks and has the following options: short JAN 2013 $47.00 puts on Starbucks. Motley Fool newsletter services recommend Krispy Kreme Doughnuts 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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