Krispy Kreme in 2014

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 are a believer in Krispy Kreme Doughnuts (NYSE: KKD) then this was a validating week for you.  After they released their earnings, the stock skyrocketed 25% to new highs for the year.  Several of us have believed in this company's potential.  I recently wrote an article called 3 reasons not to give up on Krispy Kreme.  Fellow blogger AnnaLisa Kraft did me one better with her fantastic article Krispy Kreme's Hot-Now Earnings Preview.  For bulls like me, seeing our hopes materialize in the earnings release has got my head buzzing with excitement (it feels much like the sugar high I get after eating 6-7 original glaze donuts...)

Krispy Kreme Right Now

We have seen that Wall Street obviously loved this quarters earnings release, but just how good was it really?  The short answer:  really good.  Here are the highlights:

  • Revenue up 8.5%
  • Operating Income up 66%
  • Adjusted Earnings per Share up 71%
  • 16th consecutive quarter of same store sales increase
  • 20 new locations for the quarter
  • New agreement to expand internationally into Singapore

I think you'll agree that's a whopping fine quarter for a company that just a couple years ago looked about as lost as a blind goose in a blizzard.  But was the quarter too good?  I mean, should we assume that numbers like this are really just a fluke?  These question should be on investors' minds.  Fortunately, management has already addressed the question in a two-fold manner.

On one hand, commodity prices helped them out for the quarter.  In fact, when asked, CFO Douglas Muir said "...our math suggests that we benefited by about $700,000 from lower commodity costs all in the quarter compared to last year..."  Adjusted net income was $8.3 million, or $0.12/share.  If you take away the commodity bump, that puts net income at $7.6 million, or right at about $0.11/share.  When compared to just $0.07/share last year, it would have still been fantastic growth without the commodity bump.

But on the other hand, this quarter didn't have any one-time income boosters, like the Krispy Kreme Mexico sale.  The numbers for this quarter are the numbers.  

Krispy Kreme Next Year

CEO James Morgan said "Fiscal 2013 is shaping up to be a banner year for Krispy Kreme..."  (emphasis mine) What's got him so excited?  Is he just on an earnings high, or should we actually take that comment seriously?

Krispy Kreme has raised their guidance about $2 million dollars, to $34-36 Million for the year.  Mr. Market is loving it.  If this company could pull off $36 million next year, that would represent year-over-year growth of 40%.

There are several reasons to believe that this is achievable.  Krispy Kreme has locked in a lot of their food costs already.  Sugar has already been purchased into 2015.  They are having a hard time locking in flour prices though, which is a big part of the cost of making doughnuts.  But when you look at the picture as a whole, things look pretty good when it comes to cost.

International expansion is, and will continue to be, a big part of what is going on here.  I don't believe we have seen much yet in terms of profit, but this is getting ready to take off.  They have two deals to do business in India.  Russia is underway.  They have just announced their plans for Singapore.  And then they keep throwing out little hints of more deals in the pipeline that have not been announced yet.

Banner year?  Yeah, I think it's very possible if not probable.  Everything right now is looking up.

Krispy Kreme in 2014

Believe or not, this company is so far-sighted that they have already dished out some ideas of what 2014 might look like.  While still a little early, management is hoping for profits between $38-42 Million, which means earnings per share between $0.49-0.55/share.  

Ok, so what?  What if they're right?  Let's assume for a moment that Krispy Kreme hits their current outlook for 2014.  The P/E ratio is currently very low despite the big growth right now.  KKD has been trading with a low P/E ratio in part because of low investor confidence, but also because this ratio just looks low because of deferred taxes.  If the taxes hadn't been deferred, the P/E would be higher.  

All in all, things seem to be coming around with this business.  What would a Krispy Kreme with a normal P/E ratio look like with the earnings they are expecting in 2014?

Company P/E Ratio Stock Price
Dunkin' Brands (NASDAQ: DNKN) 66.90 $30.04
McDonald's (NYSE: MCD) 16.14 $85.68
Chipotle Mexican Grill (NYSE: CMG) 31.21 $268.46
Krispy Kreme today 4.11 $9.33
Krispy Kreme 2014* 20 $11

*This is completely speculative and based on them hitting the high end of their 2014 goal

Did your heart just sink?  I'm sorry for that, but mine did too.  Let me explain some rationale behind this chart. Dunkin' is included for comparison because they are the most direct competitor.  McDonald's is included because they compete in the beverage arena, and because McDonald's is a big company, not a small-cap like KKD.  Chipotle is included because they are a big growth story, and I wanted to show what some growth stocks carry for a P/E ratio.

I think that giving Krispy Kreme a P/E ratio of 20 is very conservative considering how fast they're growing.  Here's the unfortunate part of this growth story:  as profits increase, taxes will also increase to rob shareholders of some potential profits they may have seen otherwise.  With this, what I feel is a very conservative estimate of their future P/E ratio, it represents about an 18% stock price gain in the next two years.  

Perhaps not what you were hoping for as an investor.  An awesome entry point was in August at $6/share.  If you had gotten in there, you would be looking at a possible double over the next 2 years.  While 18% may not light up your world, it's still better than the 1% you'll get in your bank.  It's also better than losing money in the market.  I really feel like 18% is both conservative and reasonable.

Conclusion

This company is no doubt going in the right direction.  They are starting to see results from years of hard work, and the future is bright.  While I don't think this will ever be the growth story of the decade, it still represents a solid company and worth a closer investor look.


thequast owns shares of Krispy Kreme Doughnuts. The Motley Fool owns shares of Chipotle Mexican Grill and McDonald's. Motley Fool newsletter services recommend Chipotle Mexican Grill, Krispy Kreme Doughnuts, and McDonald's. 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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