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SEPTEMBER 27, 2004
Why Krispy Kreme Is Worth A Bite Are doughnuts poison? You might think so, from a look at Krispy Kreme Doughnuts' (KKD ) stock chart. Under $12, the stock's off 77% in 13 months. Yet few on Wall Street see an opportunity. Indeed, the stock is nearly inedible to investors, who fret over the low-carb craze, not to say Krispy Kreme's own many blunders. Although you might call me the Will Rogers of doughnuts (never met one I didn't like), Krispy Kreme's shares never tempted me. Way too rich. Yet now I'm wondering: Is all the bad news already reflected in the stock? Investors are giving Krispy Kreme a market value of $750 million, putting it 24th on the list of restaurant stocks, well below even such careworn names as Panera Bread (PNBA ). Are they overreacting? INDISPUTABLY, THE STOCK presents some glaring risks, starting with the Securities & Exchange Commission's probe into how Krispy Kreme bought back franchise rights in such markets as Dallas. Whether the SEC ultimately will force Krispy Kreme to account for these deals differently is a question mark. Another is future profit growth. Krispy Kreme first said it expected earnings this fiscal year, ending January, of about $1.17 a share, a 29% gain. In May, it revised that to $1.05 or so. In July, when Krispy Kreme disclosed the SEC's inquiry, it noted that the agency also was questioning the lower estimate. On Aug. 26, it quit forecasting earnings. Hardly an alluring outlook. Just the same, these worries may pose less danger to investors than to management's credibility. Take the SEC. Although the agency does not discuss its probes, Krispy Kreme described the inquiry as informal. Let's say, though, that it turns more serious, and Krispy Kreme ends up restating its books. That might prove humiliating for Chief Executive Scott Livengood. He is not talking now, but in July he declared: "We are confident in our practices." For investors, however, it would hardly spell fresh financial trouble. If Krispy Kreme had to take the extreme step of writing off all of the $124 million in reacquired franchise rights that it booked as intangible assets in fiscal 2004, it would post a huge special loss and slash shareholders' equity, to $4.98 a share from $6.94. But even in this drastic -- and highly unlikely -- event, cash flow would be untouched: The dough Krispy Kreme spent to buy those franchise rights is long gone. It's history.  A bigger imponderable to me is Krispy Kreme's future profits. In August, the company told analysts it would slow its expansion, which took it to 427 stores now from 218 in February, 2002. One aim of the more tepid growth plan is to focus on widening margins at newer stores. Another is to use capital more sparingly via more modest stores, which rely on smaller machines to produce fresh, hot doughnuts. What might these moves produce? Better cash returns. In this year's first half, Krispy Kreme posted operating cash flow of $50 million, up from $38 million the previous year. Suppose the company can match fiscal 2004's full-year cash flow of $95.6 million. Then, because Krispy Kreme now is spending less on expansion, it could wind up with substantial free cash flow -- that is, cash after capital spending and acquisitions -- for the first time since going public.Don't expect Krispy Kreme to regain its status as a cult stock. Yet the shares have room to rise. The Street's bearish consensus on earnings is 69 cents a share this fiscal year and 81 cents in 2006. That means the stock's price-earnings ratio is less than 0.9 times its expected growth rate. The average comparable figure for other restaurant stocks is 1.3 times. With apologies to Will Rogers, who once quipped that if a stock "don't go up, don't buy it," Krispy Kreme is a buy.  By Robert Barker
BW MALL
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