Krispy-Kreme Getting Creamed: Buying Opportunity?

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Source: Krispy Kreme

Krispy Kreme Doughnuts fell by more than 14% on Tuesday after the company´s earnings report disappointed investors. The market could be overreacting to the negative news, however considering both quality and valuation, Starbucks and Dunkin' Brands look like superior alternatives in the sector.

Not so sweet anymore
While earnings per share met analysts´ expectations during the quarter, revenues came in lower than expected. Even worse, Krispy Kreme cut its earnings guidance for the coming year, which is always an important reason for concern among investors, as it could be interpreted as a sign of increasing difficulties down the road.

Sales during the quarter ended on May 4 came in at $121.6 million, an uninspiring increase of 0.8% versus the same period in the prior year and lower than the $126.7 million forecasted on average by Wall Street analysts. Excluding the effects of refranchising stores, revenues increased by 2.1% year-over-year.

System wide store count increased 3.3%, and Krispy Kreme ended its fiscal year 2014 with a total of 855 stores around the world, including both company-owned and franchised locations. Same-store sales at company-owned stores declined 1.5% during the quarter, while same-store sales in international franchised locations fell by a worrisome 4.5%. Measured on a constant dollar basis, same-store sales in international franchised stores decreased 2.2%.

Domestic franchised stores were less affected by the unusually cold weather during the period, so same-store sales in these locations increased 4.5% during the quarter.

The company performed better on the profitability front, Krispy Kreme delivered improving profit margins, and adjusted net income increased 12.2% to $15.8 million versus $14.1 million in the year ago quarter. Adjusted earnings per share grew from $0.20 to $0.23, which was in line with analysts´ expectations.

On the other hand, management reduced its guidance for fiscal 2015 from between $0.73 and $0.79 in adjusted earnings per share to between $0.69 and $0.74.

According to CEO James H. Morgan, "The change reflects, among other things, our first quarter performance, higher than anticipated investment in a new enterprise resource planning system and higher costs than we had planned associated with executive management succession."

Forward guidance is materially below analysts´ forecast of $0.78 in earnings per share for the year, even if it would still mean a growth rate in the range of 13% to 21% versus fiscal 2014. Besides, there is never just one cockroach in the kitchen, and it's hard to tell at this stage if this will be the last downward adjustment to financial guidance or if it's a sign of more problems to come.

Krispy Kreme Doughnuts vs. Starbucks and Dunkin' Brands
Krispy Kreme trades at a forward P/E ratio near 20.4, a relative discount in comparison to peers such as Starbucks and Dunkin' Brands, which trade at forward P/E ratios of 23.4 and 22 respectively.

However, there is much more to investment decisions than simply comparing valuation ratios, and quality differences may be more than enough to justify a valuation premium for both Starbucks and Dunkin' Brands versus Krispy Kreme.

Starbucks is unquestioningly the best player in the industry: brand differentiation, rock-solid profitability, and a culture of innovation make Starbucks one of a kind. The company has built a global empire with more than 20,500 stores around the planet, and demand remains remarkably strong for a company of its size.

Starbucks delivered a 9% increase in sales during the quarter that ended on March 30 to $3.9 billion, while same-store sales grew 6% during the quarter. Net sales in the Asia/Pacific region were particularly strong with an annual increase of 24% during the period, indicating that Starbucks is benefiting from steaming-hot demand in emerging markets.

Dunkin' Brands offers a simpler and lower-priced proposition to customers, even if the company was hurt by challenging weather conditions during the first quarter of 2014, Dunkin' Brands is still generating acceptable performance under challenging conditions.

Dunkin' Brands announced a total increase in revenues of 6.2% during the first quarter of 2014. Dunkin' Donuts U.S. suffered from marginally declining traffic during the period, but consumers purchased more items per transaction, which allowed the company to produce a 1.2% increase in comparable-store sales in its U.S. Dunkin' Donuts division.

Even if Starbucks' and Dunkin' Brands' stocks are more expensive than Krispy Kreme, the relative pricing discount is not big enough to merit a position in Krispy Kreme over its stronger peers.

Foolish takeaway
Investors tend to put too much weight on short-term information, especially when it comes to negative news, so the recent decline in Krispy Kreme could easily turn out to be an exaggerated reaction. However, even if they are a bit more expensive, Starbucks and Dunkin' Brands look like sounder alternatives in the industry.

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The article Krispy-Kreme Getting Creamed: Buying Opportunity? originally appeared on

Andrés Cardenal has no position in any stocks mentioned. The Motley Fool recommends Starbucks. The Motley Fool owns shares of Starbucks. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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