WSJ -- Krispy Kreme Analysts Fret Over Growth Strategy.
November 26, 2003
Krispy Kreme Analysts Fret Over Growth Strategy
By MARY ELLEN LLOYD
Of DOW JONES NEWSWIRES
CHARLOTTE -- Some Wall Street firms seem to be losing their craving for Krispy Kreme Doughnuts Inc. (KKD)
Two of six analysts following the treat-maker cut their investment ratings on the stock to hold after Krispy Kreme posted third-quarter earnings last week that met analysts' forecasts. Those downgrades swung the consensus recommendation to hold from buy, according to Thomson First Call's survey of six analysts tracking the Winston-Salem, N.C., company.
Of six analysts reporting to First Call, two rate the stock at outperform, three at hold and one at underperform.
Analysts worry that Krispy Kreme's days of record-breaking store openings are winding down as the 333-store chain enters a new phase of its development. Krispy Kreme's first Massachusetts store, for example, set new records when it opened in June near Boston, selling nearly $507,000 its first week. Krispy Kreme says break-even for its stores is $20,000 a week in sales.
But Krispy Kreme announced Friday it has completed its entry into large U.S. markets and will begin back-filling those regions and entering smaller markets. Store openings in those markets are unlikely to generate the same level of publicity and sales as initial stores in a market, company executives and analysts have said.
Also worrying analysts is whether smaller outlets and overseas stores, expected to play a key role in this next stage of the chain's expansion, will lead to slower earnings growth or lower returns in the near term.
"Longer term, we remain believers in Krispy Kreme's growth opportunity, but changes in direction, and the possible increase in risk profile that they bring, merit a more cautious approach," CIBC analyst John Glass said in his research note Friday downgrading the stock to sector performer from sector outperformer.
The focus next year on satellite stores in particular increases risk and could hurt financial results due to pre-opening expenses and the costs to build infrastructure for the next leg of growth, he wrote.
BB&T Capital Markets analyst Andrew Wolf downgraded the stock to hold from buy.
"In summary, 2004 appears to be shaping up as a transition year, during which earnings growth should slow modestly, while management refines its new domestic growth vehicles, and international expansion marches on towards likely eventual profitability," he said in a research note. "We believe the sideline is the appropriate place to be during such a time."
Wolf expects per-share earnings will increase 38% this year to 81 cents but decelerate to 30% growth, or $1.18 a share, next year. He also reduced his three-year EPS growth forecast to 30% from 35%.
Analysts polled by Thomson First Call forecast earnings of 91 cents this year and $1.16 a share for the fiscal year that ends January 2005.
Shares of Krispy Kreme recently traded at $40.90, down 10 cents, or 0.2%, on volume of 368,800 and average daily volume of one million.
Company Says It's On Track
For it's part, Krispy Kreme says its business strategy is on track.
"I couldn't be more pleased about what we have accomplished and more optimistic about our prospects," Chairman and Chief Executive Scott Livengood told analysts during the company's conference call.
Per-share earnings of 23 cents were 35% higher than a year earlier and a penny ahead of company guidance. Systemwide same-store sales increased 9.5%. Other restaurant companies boosted per-share earnings about 2% in the third quarter, with same-store sales rising an average 1.9%, according to BB&T Capital.
But bears continued to say declining average weekly sales at Krispy Kreme's stores are contributing to lower-than-expected systemwide sales. Systemwide average weekly sales fell 3.2% from a year earlier, after a 1.1% decline in the second quarter.
Chief Operating Officer John Tate said in an interview Wednesday that analysts' concerns over near-term results may be shortsighted.
Sure, smaller stores will inherently sell fewer doughnuts than the company's factory stores, which produce hot doughnuts for sale at the store and also ship to third-party vendors. But the smaller stores will help increase Krispy Kreme's market penetration, and returns should be comparable, given the lower costs associated with them, he said.
Indeed, the increased number of smaller stores, Krispy Kreme's early success overseas and its opportunity to increase sales in acquired markets, Tate said, "gives us confidence we can sustain 25% to 30% revenue growth as far on the planning horizon as we could see." The accelerated development of smaller stores will help increase Krispy Kreme's market penetration, he said
"If a slight reduction in return on equity...reflects a business problem, that's a problem," he said. "If it reflects an investment in the future for proven earnings growth, we'd be prudent to make that investment."
Many on Wall Street have long been skeptical of Krispy Kreme shares, which have gained more than 700% since their IPO and have been a favorite of short-sellers. Krispy Kreme is the top performing IPO based on percentage gain since its debut, The Wall Street Journal has reported. But it remains pricey on a price-to-earnings basis, trading recently at around 36-times next year's estimated earnings, compared with a restaurant industry average multiple of around 19.
Other analysts aren't as worried, and many still consider Krispy Kreme's growth impressive.
"Their growth is going to slow, but it's slowing from very high levels," said Dennis Milton, an analyst with Standard & Poor's Equity Research, who rates the stock at hold because of its valuation.
Krispy Kreme is in the early phase of its growth cycle, said Thomas Weisel Partners analyst Skip Carpenter, who rates Krispy Kreme at outperform.
"Our outperform investment rating...reflects our view that this business possesses one of the strongest growth stories in our universe coverage with a business model capable of generating +30% EPS growth over the next five years," he wrote in a research note.
Carpenter couldn't be reached immediately to determine whether he owns Krispy Kreme shares. Wolf, Glass and Milton don't own shares. CIBC, BB&T and Thomas Weisel expect to receive or seek investment-banking fees from the company, and other affiliates of Standard & Poor's Equity Research may offer services to the company.
Corporate web site: krispykreme.com
-By Mary Ellen Lloyd, Dow Jones Newswires; 704-371-4033; maryellen.lloyd@dowjones.com
Updated November 26, 2003 3:53 p.m.
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