Krispy Kreme: Strong Organic Growth and Cost Pressures

The iconic donut producer is entering a new growth phase

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Aug 22, 2022
Summary
  • Krispy Kreme sells fresh donuts and coffee in over 30 countries.
  • Labor and cost pressures are making income growth difficult.
  • Krispy Kreme is not very profitable, but the company expects 20% earnings growth over the long-term.
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Krispy Kreme Inc. (

DNUT, Financial) operates one of the most popular donut chains in America. As of Jan. 2, the company had 1,810 Krispy Kreme and Insomnia Cookies branded shops in approximately 30 countries worldwide, which include 971 company-owned and 839 franchised. It sells its products through doughnut shops, delivered fresh daily outlets and e-commerce.

Krispy Kreme was founded in 1937 and is headquartered in Charlotte, North Carolina. The company had been private for quite some time and went public in July 2021. It currently has a market capitalization of $2.0 billion.

As the company faces mounting cost pressures, investors are worried that the stock of this iconic donut chain will turn out to be a bust. However, the company is deliverying strong organic growth and believes its long-term prospects are solid.

Recent earnings

The company recently reported second quarter results which showed strong organic growth of 8.9%. Sales per hub in North America increased by 22.2% year-over-year to $4.4 million while international sales per hub grew 22.5% to $9.8 million. Organic growth was driven by the performance and expansion of the company’s omni-channel model. Global points of access, which is all locations where the company's fresh doughnuts and cookies can be purchased, increased by 382 during the quarter to approximately 11,400 locations globally.

However, labor and commodity cost issues caused operating income to decline 17.7% and Ebitda to decline 9.6%. Management stated it has taken pricing actions subsequent to the end of the second quarter and has also seen commodity costs decline.

At the end of the quarter, the company had $25.8 million of cash and cash equivalents, $700.7 million of bank debt and $28.1 million of other debt. The company also has more than $225 million of available liquidity. The company hopes to reduce its leverage ratio to 3 by the end of 2023.

Growth plans

The company plans to increase growth and profitability by focusing on three main tenets:

1) Increase trial and frequency by marketing expansion and product innovation.

2) Increase availability by increasing fresh points of access in new and existing markets.

3) Increase profitability by driving extra efficiency benefits from omni-channel execution.

Krispy Kreme values the global “indulgence” addressable market at $650 billion, and markets in which the company currently operates are $350 billion in size. The company has a long-term goal of increasing total points of access (shops and retail shelf space) from approximately 10,000 to 50,000. There are 1.3 million grocery and convenience stores in in the U.S. which could potentially be new points of access and increase the market exposure.

Valuation

The company recently updated its 2022 full year guidance. It now calls for organic revenue growth between 10% and 12% as well as adjusted Ebitda between $189 million and $195 million. Adjusted earnings per share is expected to be between $0.29 and $0.32.

That puts Krispy Kreme selling at 38 times this year's earnings estimates. The company typically reports high levels of depreciation and amortization as well as elevated levels of interest expense, which weigh on earnings numbers.

The GuruFocus discounted cash flow calculator estimates a fair value of approximately $15.00 for this stock when I plug in next year's normalized earnings per share as a starting point and assume a 15% earnings growth rate (my personal estimate) over the next 10 years.

Guru trades

Gurus who have purchased Krispy Kreme stock recently include

Chuck Royce (Trades, Portfolio) and Ron Baron (Trades, Portfolio). Gurus who have reduced their holdings include Paul Tudor Jones (Trades, Portfolio).

Conclusion

Although Krispy Kreme trades at a high valuation and is struggling with profitabilty, I believe it could still be a long-term opportunity due to the possibility of double-digit growth. The company provides a long-term outlook of organic revenue growth in the 9% to 11% range, Ebitda growth in the 12% to 14% range and core net income growth of 20% at the mid-point.

I think this could be achievable if the company hits its long-term goal of increasing points of access to 50,000. In addition, the company is in early stages of its expansion into other food categories such as cookies and packaged treats. Krispy Kreme’s products may be somewhat recession proof as they offer a very affordable indulgence spending item.

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Disclosures

I/we have no positions in any stocks mentioned, and have no plans to buy any new positions in the stocks mentioned within the next 72 hours. Click for the complete disclosure
Rating:
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