http://www.businessweek.com/stories/2003-10-02/a-little-less-sweetness-at-krispy-kreme

A Little Less Sweetness at Krispy Kreme


By Eric Wahlgren The hottest news out of the vats from Krispy Kreme (KKD): It may soon be testing palates in China to see if its 1.3 billion consumers have a Homer Simpson-like taste for glazed doughnuts. Then again, a warm reaction overseas may be just the sugar high the Winston-Salem (N.C.) fast-food outfit needs because Wall Street seems to have lost its sweet tooth for KK -- at least for a while.

Witness the stock's swoon lately -- it has lost about 20% of its value since early August, now trading at around $40 a share. Better yet, take BusinessWeek Online's KREMEY index, an acronym for the Krispy Kreme Euphoria Yardstick. For the first time since April 5, 2000, when KK became a publicly traded company, our basket of dot-com stocks, devised expressly to compare silicon to sugar, finally outperformed the hard-charging doughnutmaker. The KREMEY index has risen 97% year-to-date, vs. an increase of only 16% for Krispy Kreme stock.

Our methodology is simple: Let's say that on the first day of market trading in 2003, you bought 10 shares each of the 9 Internet stocks in the KREMEY: Amazon.com (AMZN), America Online (now AOL Time Warner (AOL), eBay (EBAY), E*Trade (ET), CNET (CNET), iVillage.com (IVIL), Priceline (PCLN), TheStreet.com (TSCM), and Yahoo! (YHOO) (eToys was the 10th index stock, but it's no longer around). We also assume the same sum used to buy the index would have been spent the same day to purchase a stake in Krispy Kreme.

UP FROM NOTHING. A swoon? Yes -- but don't let 2003 fool you: Over the life of the KREMEY, Krispy Kreme has put silicon to shame. If you had put $5,400 in Krispy Kreme stock when it went public at $21 a share three years ago, your investment would have grown 665%, to $41,326, even at today's lighter trading price. Putting the same sum into the KREMEY would have left you with a paltry $2,107 now -- a 61% long-term drop, despite 2003's partial recovery.

Indeed, the KREMEY's bubble-esque rebound in 2003 may say more about how beaten down dot-com shares really were than anything going on with Krispy Kreme. Many of the index' dot-coms came off a dreadfully low base at the beginning of the year, so any increase in value constituted a substantial hike, measured in percentage terms. Consider, too, that the benchmark Standard & Poor's 500-stock index is up about 12% this year. Krispy Kreme, with a 16% gain year to date, has handily outperformed that.

Behind its summer-to-fall stock-price drop are lowered ratings from several analysts. The recent downgrades came after the outfit reported that average weekly sales during the most recent quarter (its second for fiscal 2004 ended Aug. 3) dipped 1.1%, a sign that some of the new stores have not seen the same sugar-crazed mobs that marked earlier outlets' debuts. Result: It shed a few pounds from its 52-week high of $49.74.

NOT MUCH ROOM LEFT? Krispy Kreme's earnings-per-share growth has been decelerating as well, from around 61% in 2002 to 47% in 2003, and to a 2004 estimate of 38%, according to First Call's figures. When a business grows, it becomes harder to show bigger gains. The growth rate remains impressive, but it raises the issue of whether Krispy Kreme can justify its high price-earnings multiple. The stock is still trading at about 42.3 times fiscal 2004 earnings, First Call says.

Typically, analysts like to see a growth rate higher than a company's p-e ratio. "This might suggest that the stock doesn't have a lot more room to go up, unless something changes, such as it can accelerate its growth rate," says Peter Cohan, founder of venture-capital and management-consulting firm Peter S. Cohan & Associates and the author of investment book e-Stocks.

Kathleen Heaney, specialty retail analyst in New York at brokerage outfit Maxim Group, took notice of this earlier this year, cutting her rating on Krispy Kreme's stock to hold, from buy. John Ivankoe, a JP Morgan analyst in New York, who also lowered his rating on Krispy Kreme to underweight from neutral, recently wrote: "We believe the issue of new-unit productivity [volume at newly opened outlets] increases the risk that future earnings upside won't be achieved and adds operational risk as more store growth is required to achieve previous targets." (Invankoe and Heaney and their firms own no Krispy Kreme stock.)

FOREIGN TASTES. Krispy Kreme CEO Scott Livengood, however, says it's more important to focus on per-capita sales and sales at stores open at least one year, both of which have been rising. Using that measure, he says, comparable sales jumped 11.3% in the second quarter, topping company forecasts and suggesting that the public's appetite for Krispy Kreme doughnuts is as strong as ever. "Our business model has never been predicated on large opening volumes," says Livengood. "The economics are driven by the way our business model matures."

That involves opening so-called factory stores, where doughnuts are made for larger distribution, followed by smaller outlets. And by the end of October, Krispy Kreme plans to open test stores in five Wal-Mart locations -- tapping into the mega-retailer's customer base. As of Aug. 21, Krispy Kreme, which already owns or franchises some 307 stores, mainly in the U.S. and Canada, claimed it's on track to expand its store count by 28% in its fiscal 2004 year, opening up an additional 87 outlets.

Though Livengood says he doesn't comment on his outfit's stock price, he says the investment community has a lot of confidence in Krispy Kreme's brand, strategy, and direction. Some of that direction is overseas, says Livengood, who was speaking from London, where Krispy Kreme plans to open its first British outlet in posh department store Harrods on Oct. 3.

DOWN UNDER DELIGHT. That will count as the second overseas presence after an opening in suburban Sydney, Australia, earlier this year. Mexico is likely next on the list, while Japan and Korea are priorities too, he says. As for China, Krispy Kreme is just beginning due diligence. "That will probably be over a longer period of time," Livengood says.

Analysts are more skeptical. "I'm not sure foreigners are going to be as taken with their products as Americans. It's a wait-and-see," says Standard & Poor's equity research analyst Dennis Milton. Even if Krispy Kreme is right, "I see [overseas] as icing on the cake," he notes. Milton recently upgraded his rating on the doughnutmaker from avoid to a hold, with a target price of $42. (Milton has no Krispy Kreme ties, nor does S&P.)

It just goes to show that even the hottest stocks -- just like hot doughnuts -- cool off eventually, even ones with good prospects and track records like Krispy Kreme. Wahlgren covers the markets for BusinessWeek Online in New York


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