WSJ -- SMARTMONEY.COM: A Talk With Krispy Kreme CEO Livengood.
May 27, 2003
SMARTMONEY.COM: A Talk With Krispy Kreme CEO Livengood
By SCOTT PATTERSON
Of SMARTMONEY.COM
LEGEND HAS IT that the Pilgrims brought doughnuts to America. Discovered in Holland, where they were called "dough knots" (this was before the ubiquitous center hole), the tasty treats fried in boiling oil were likely a staple dish at the first Thanksgiving.
Which is a little ironic since, on Nov. 2, 2000, a few weeks before the first Thanksgiving of the new millennium, Krispy Kreme Doughnuts (KKD) hit its all-time high share price of $108.50, unadjusted for stock splits. Since then, the company, which has a market cap of about $1.8 billion, has had two 2-for-1 stock splits, and shares have leveled out in the mid-$30s. On Wednesday, Krispy Kreme will announce results for its first quarter ended April 3. The Reuters Research consensus estimate is for net income of 20 cents a share, up from 15 cents a year ago.
The company's shockingly strong performance since its April 2000 initial public offering has prompted shareholders to give thanks, too. Krispy Kreme President and Chief Executive Scott Livengood, who joined the Winston Salem, N.C., company in 1977 as a human-resources employee, has transformed the once small-scale Southeastern wholesaler into a national - and soon-to-be global - giant. Krispy Kreme operates 278 stores in the U.S. and Canada, and plans to open franchises in Mexico, Australia and Europe.
The big question about Krispy Kreme, however, is whether it deserves its yeasty valuation. The stock certainly has its share of naysayers - who from time to time have had to wash down the company's stellar earnings results with large orders of crow.
One number skeptics point to is the doughnuteer's forward-price/earnings ratio. Krispy Kreme trades at 35 times Reuters Research's 2003 earnings consensus of 88 cents, compared with just 18 for the Standard & Poor's 500. But its 2003 P/E matches that of specialty retailer Starbucks (SBUX), which is often compared to Krispy Kreme. And analysts expect Krispy Kreme to increase earnings at 32.5% annually over the next five years, compared with 21% for Starbucks. That gives it a price/earnings-growth, or PEG, ratio (P/E over earnings-growth rate) of 1.08, far cheaper than Starbucks' 1.67 or the S&P 500's 1.47. A clear-cut case of overvaluation this is not.
SmartMoney.com asked the company's master chef, Livengood, how he has transformed Krispy Kreme from its modest wholesaler origins, what he plans to do to keep it growing and whether he has plans to introduce a line of fat-free doughnuts anytime soon.
SmartMoney.com: What was Krispy Kreme like back in 1977, and how has it
changed?
Scott Livengood: It was very, very different. Krispy Kreme from the first day was about wholesale. It's always been in response to the customer's interest that we've sold doughnuts on the premises. Back in the 1930s, people sought out the store, and the owner had to cut out a hole in the production room and start selling doughnuts right there. In the 1980s and '90s, the hole had grown to a small glass box on the front of the factory. It was an environment focused on cost control, manufacturing efficiencies and the generation of volume through off-premises sales. The environment today is part of a revision of the company's strategy. Now, the in-store experience is the defining element of Krispy Kreme. This was a wholesale business that created retail opportunities. We turned that upside-down, with retail coming first and wholesale emanating from that.
SM: With the U.S. economy in the doldrums, how has Krispy Kreme continued to
grow and consistently beat earnings forecasts?
SL: I think the change in the business model created the platform for growth. We couldn't have grown with the previous business model. Our stores were marginally profitable. So the repositioning created a platform to grow because it was focused on the store. In terms of our growth in a difficult economic environment, what's worked to our advantage is that Krispy Kreme doesn't have a well-defined demographic market. Our customers are the mirror of a community - we draw from the entire community. And our product is very affordable. I also think our doughnuts are comforting, both because of the type of product that it is and the fact that we've been around for decades.
SM: What are your expansion plans for the next few years?
SL: We started early on to develop relationships that would lead to strong franchise partnerships. We didn't just pick an area and say we're going to go in and deeply penetrate this part of the market. A lot of companies do that when they want to generate the kind of presence that makes media advertising more affordable. We've been fortunate in that we haven't needed to spend media dollars to build our brand. In fact I think in a lot of ways that would work against us. So we have virtually zero ad spend. And we've recently announced that we're opening stores in Mexico, we're opening our first store in Australia in June, and I think there's a good chance we'll open our first store in London later this year.
SM: Krispy Kreme added premium coffee to its product line in 2001 with the
purchase of Digital Java. What was the motivation for that move, and how is that
going?
SL: We've made coffee for decades, but we wanted to control the process. Our central strategic imperative for everything we do is centered on elevating the customer experience. That's what's repositioned and redefined our prospects as a company. It's not a lot of new things, [but rather] doing old things in new ways and doing them better. As a direct result of the new coffee line, our sales are up well over 30%. That rise was simultaneous with the rollout and promotion of that last year.
SM: Krispy Kreme has often been compared with the highflying tech stocks of
the bubble. How do you see that comparison?
SL: They were pretty low-flying when we went public. The worst day in Nasdaq history was the day before we went public [on April 5, 2000], if you can believe that. It was a scary 24 hours. The bottom had fallen out. We didn't know if the mood was so bad that no one would want to buy any stocks. But I think it actually worked to our advantage to be something that is, at least at the store level, fairly low tech. It was a story that everybody understood. We had earnings, and we had defined prospects. I think it played to everything that the tech stocks that struggled didn't have.
SM: Were you surprised by how high the company's stock has soared?
SL: To be honest, I could never say that I predicted that we'd have the reception that we did, so quickly. I did expect things to go very well. I was optimistic, because I've been going to our store openings for years now, and when you go to one of those openings and see people camping out with lines wrapped around the building and cars spilling out to exit ramps on freeways - mile-plus-long lines at the drive-thru - you know you're connecting with people in meaningful ways. So I felt, in terms of the Peter Lynch school of investing, that there would be a lot of folks who knew about Krispy Kreme. We also had substantial institutional interest. Everyone that we called on bought stock in the offering. And I think that would have happened regardless. It's the power of branding and the prospects of the company. How many 65-year-old companies that have their artifacts in the Smithsonian are in the early infancy of their growth?
SM: Krispy Kreme shares have a forward P/E of about 35 - quite high for the
restaurant industry. Do you think that valuation is sustainable?
SL: That's about half of where it was a year ago. But I really don't comment on the stock price. As much as I'd like to control it, I can't. If I could make predictions with accuracy, I would. The thing I'm sure of is that the markets like consistency and predictability. They like to be told the truth and to trust the management teams that run the companies. Those are things that I can control. I feel like we've been effective and successful at demonstrating that we're worthy of that kind of confidence. Beyond that, we let the market do its job.
SM: Are you worried about lawsuits like the recent McDonald's (MCD)
class-action suits for customer obesity?
SL: I see what's going on, and I hear about the trial-lawyer focus on the industry. I don't obsess or worry about it. At the end of the day, I think that wisdom and level heads prevail. I trust our justice system. We don't masquerade as a health food. We're not doing advertising campaigns touting the health benefits of the product.
SM: No plans for a low-fat doughnut line?
SL: I think that's a contradiction in terms.
Updated May 27, 2003 6:48 p.m.
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