| | Krispy Kreme Sales Seem to Show Signs Of a Sugar Crash
By MARK MAREMONT
Staff Reporter of THE WALL STREET JOURNAL
Krispy Kreme's doughnuts might win raves, but sales at some of the company's stores appear to be surprisingly soggy.
The company, of course, is one of the great fast-food stories of the past decade, garnering rhapsodic raves for its signature hot-glazed doughnuts and a devoted circle of Wall Street fans. Krispy Kreme Doughnuts Inc. shares are up eightfold since the Winston-Salem, N.C., company went public in 2000, defying the market's drop since then, and have gained 26% this year.
But there are new signs that the company's numbers may not be as sweet as many investors have thought.
Internal figures reviewed by The Wall Street Journal cover results for roughly 40 Krispy Kreme outlets that opened between September 2002 and April 2003, most of the stores that opened during that period. On average, the stores posted weekly retail sales of about $35,000 during the 13 weeks ended Aug. 4, below what the company says is the norm for its newer outlets -- and well below what some investors expect for a retailer whose new stores tend to open particularly big thanks to the company's large following.
Then there is the company's biggest franchisee, Great Circle Family Foods LLC, which has 22 stores in Southern California. People who have examined Great Circle's books say its same-store sales, including wholesale shipments from those stores, fell 10% in its latest quarter. The closely held company, based in Los Angeles, put itself up for sale earlier this year, but no deal has yet been announced.
During its fiscal second quarter ended Aug. 4, Krispy Kreme's same-store sales rose by about 10%.
While overall revenue at Great Circle rose due to its fast-growing wholesale business, guest counts at its outlets -- a key restaurant-industry measure of the number of transactions per store -- declined by nearly 20%.
Calls to Great Circle were returned by its investment banker, Michael Shepardson of CNL Advisory Services in Orlando, Fla., who won't comment on the second-quarter retail-sales numbers. But he says looking at comparable-store results is "not meaningful" because they don't take into account natural sales declines at maturing stores and the overall growth in wholesale business.
For its part, Krispy Kreme, which has 313 outlets, generally confirmed the new-store retail-sales report. But the company says the numbers are fragmentary and don't provide a complete picture of a company that has reported stunning growth in recent years, including an average 63% quarterly growth in operating earnings over the past 10 quarters.
But they do give ammunition to an argument circulating among Krispy Kreme bears: As the fast-expanding doughnut purveyor adds multiple outlets in the choicest markets, average-store sales are slowing and new stores aren't performing strongly. The company's strategy of offsetting slowing retail sales with wholesale shipments to supermarkets and other outlets, these bears argue, is inherently less profitable -- and may be tricky to execute.
Last month, John Ivankoe of J.P. Morgan Securities downgraded Krispy Kreme to "underweight," citing signs of below-par sales at newer stores in results for the company's fiscal second quarter ended Aug. 4. Reports by Mr. Ivankoe, whose firm helped underwrite Krispy Kreme when it went public, also see "an increasing risk profile" as the company pushes further into wholesale distribution.
There isn't much room for error in Krispy Kreme's stock price. Despite a recent dip, it closed Monday at $42.70, or 62 times trailing 12 months' earnings. That is far ahead of the S&P 500's average multiple of 28, and stronger even than Starbucks, Wall Street's favorite coffee shop, whose price/earnings ratio is 44.
John W. Tate, Krispy Kreme's chief operating officer, says the naysayers are wrong. He won't comment on Great Circle's results, but says the franchisee has "done a great job of building out Southern California," adding that Krispy Kreme itself would like to buy the operation at the right price,
Mr. Tate says the report on the 40-odd newer stores provides only a "limited set of data points" that aren't relevant in analyzing the wider company. He says the report ignores the wholesale sales made by those stores, which for some of the outlets was more than equal to the retail volumes. While he acknowledges that the 40 stores on average produced total sales, including wholesale, below par for Krispy Kreme outlets, he says that is in part because of an unusual mix of stores opened in that period, which included few openings in high-profile new markets.
Speaking about average unit volumes for the company as a whole, Mr. Tate says Krispy Kreme is "exactly on our target and on strategy for our growth model."
As for the worries about the transition to more off-premises sales like grocery stores and convenience stores, he says it is a time-tested model for Krispy Kreme stores going back decades. "It's a little more complicated model," but if done correctly, it can produce the highest profit margins in the fast-food industry, he says.
But critics also point to other bearish indicators at Krispy Kreme, such as significant stock sales late last month by top company insiders, including Chief Executive Scott Livengood, who pledged last November not to sell stock for "at least a year."
Mr. Livengood says his stock sales are part of a plan he filed last September to annually sell a portion of his holdings. He calls the latest sale "totally consistent" with the "spirit" of his statement in November.
What excites many investors about Krispy Kreme is its growth potential, as the company expands from its original Southeast base -- where it was founded 66 years ago based on a secret recipe from a New Orleans chef -- to become a national brand. Although Krispy Kreme owns or controls about 114 stores itself, much of the expansion has come from franchisees who have been given rights to develop major markets.
The first store in any market typically gets a huge reception, as crowds line up to buy the fried cakes. The Boston area's first Krispy Kreme, opened in June, had a record $500,000 in sales its first week, and more than $2 million in its first seven weeks, according to the sales documents.
But some investors have begun to focus on what happens to store sales after the initial frenzy, especially as more Krispy Kremes open in a market. There the picture is more mixed. For the chain as a whole, the company has reported that average weekly per-store revenue has fallen for two quarters in a row, despite double-digit increases in same-store sales, which Krispy Kreme defines as sales at stores open more than 18 months.
J.P. Morgan's Mr. Ivankoe says that can only happen mathematically if weekly sales at recently opened stores are "meaningfully lower" than the $64,000 systemwide average. Put another way, as the chain opens its third, sixth, or 20th outlet in a region, the buzz fades, stores start to cannibalize each other and Krispy Kreme becomes just another doughnut shop, even if a very good one. "This is an issue that could get magnified as they further penetrate the domestic market, especially as high-profile openings such as Boston are a thing of the past," Mr. Ivankoe says.
A store in Tampa, Fla., that opened in November had average weekly retail sales of about $19,000 during the 13 weeks ended Aug. 4. In the Chicago area, which has 14 units, a store that opened in October in Hanover Park, Ill., averaged $25,000 weekly during that same 13-week period.
Krispy Kreme's Mr. Tate says such numbers are misleading because they ignore wholesale sales, which brought the Tampa store's weekly figures up to about $48,000 during that period and the Hanover Park outlet's to $45,000. He says stores typically have a life cycle, with many posting big numbers at the start, then settling down to a little more than $40,000 a week in retail sales after about two years. That is when Krispy Kreme models suggest that wholesale shipments should kick in.
Krispy Kreme calls its full-sized outlets "factory stores," and equips them with costly doughnut-making machinery that can churn out tens of thousands of the caloric circles daily, far more than most stores can sell at retail. The strategy, the company says, is for stores to supply nearby supermarkets, convenience stores and other outlets. Krispy Kreme says its company-owned stores, many of them long-established, average about 67% wholesale sales.
But critics say the approach carries risks, including a dilution of the brand if customers get day-old Krispies at their local supermarket instead of the piping-hot variety that has made the chain famous. They also contend that some franchisees have restaurant-industry experience and are poorly equipped to run what amounts to a distribution business.
Write to Mark Maremont at mark.maremont@wsj.com
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