The last year has not been great for Krispy Kreme Doughnuts (KKD, Financial) from a stock price perspective with the stock declining by 26.5%. The decline has been backed by fundamental factors weakening on a relative basis. While the stock has trended marginally higher by 2.0% for the year to date, I remain cautious on the stock.
With the company reporting fourth quarter 2016 results Tuesday, there are some key points worth noting. Krispy Kreme reported a 1.6% increase in comparable restaurant sales. This was below analyst estimates. The company’s trend in comparable restaurant sales is the first reason to be cautious for fiscal year 2017. For fiscal year 2016, comparable restaurant sales increased by 3.9%, indicative of the sharp decline in comparable restaurant sales witnessed in fourth quarter 2016.
The second caution point on Krispy Kreme is the company’s valuation. For fiscal year 2016, the company reported GAAP EPS of 48 cents, representing PE of 32 considering Wednesday's stock price of $15.5. Further, for fiscal year 2017, the company expects EPS to be in the range of 54 cents to 58 cents per share. Considering the midrange of the guidance at 56 cents per share, Krispy Kreme is trading at fiscal year 2017 PE of 28. These valuations are stretched with muted comparable restaurant sales growth considering the broad market valuation (Standard & Poor's 500 forward PE of 17.3). It also remains to be seen if Krispy Kreme reports improved comparable restaurant sales in first quarter 2017 or the declining trend continues.
While these are two broad concerns, I see the following positives:
- Krispy Kreme has increased the company’s share repurchase authorization by $100 million in March 2016 from $155 million to $255 million. With this increase, the company has authorization to repurchase an additional $143.4 million worth of shares. This is shareholder value creating but is likely to be discounted in the company’s fiscal year 2017 EPS guidance.
- Krispy Kreme expects to open 30 new domestic shops including 10 company shops coupled with 120 to 140 net new international franchise shops. Therefore, the restaurant openings are likely to remain robust. However, my concern is that, for fourth quarter 2015, international franchise revenue declined 3.4% to $7.4 million principally due to unfavorable foreign exchange rates. It remains to be seen if aggressive expansion outside the U.S. translates into growth in fiscal year 2017 and beyond. However, the company expects to see continued negative effects of a strong U.S. dollar.
Overall, Krispy Kreme has more concerns than positives for the foreseeable future. Considering the company’s forward valuations, it might be best to remain in the sidelines. I would also wait to see the company’s comparable restaurant sales growth trend for the coming quarters as there seem to be worries on that front. While share repurchase is value creating, investors will look for operating level performance improvements rather than an EPS boost through share repurchase.
It is also important to note here that companies like McDonald's (MCD, Financial) trade at relatively attractive valuations, have robust dividends and are also undergoing significant changes toward the better. If investors are considering exposure to the broad restaurant industry, there are better options than Krispy Kreme.
Disclosure: No positions in the stock
