Is Krispy Kreme Doughnuts a Buy?

Is Krispy Kreme Doughnuts a Buy?

Krispy Kreme Doughnutshas enjoyed a significant increase in its stock price since the bottom of 2009, from around $1.20 per share in Feb 2009 to more than $24.50 per share at the time of writing. However, its stock price dropped significantly to only $19.60 per share right after it announced a disappointing third quarter performance. Should investors consider this to be a buying opportunity, or should they stay away from the company's stock for now? Let's take a closer look and find out.

Not up to par
In the third quarter, Krispy Kreme Doughnuts managed to deliver a 6.7% growth in revenue, to $114.2 million, while its same-store sales increased by 3.7%. However, the company's sales fell short of analysts' expectations of $114.62 million. The adjusted EPS rose by 33.8%, from $0.12 per share last year to $0.16 per share this year. Another reason for the market to be bearish on this stock is the fact that the company's EPS projections for next fiscal year came in at the range of $0.60-$0.63, the low end of analysts' estimates.

If we forget all the analysts' estimates, though, Krispy Kreme actually improved its operating profitability. All of its four business segments enjoyed higher operating margins than the same period last year. In fact, the Company Store segment has achieved 20 consecutive quarters of positive same-store sales growth. The higher same-store sales were mainly driven by price increases, whereas the traffic rose only modestly.

These initiatives will drive Krispy Kreme Doughnuts forward
Looking forward, Krispy Kreme Doughnuts will continue to expand its brand outside of its retail shops, including the introduction of its packaged ground coffee in several Sam's Club locations in the Southeast. The company thinks that this initiative in Sam's Club will capitalize many consumers who brew coffee at home and at their work places. By allowing them to enjoy the company's coffee at their own convenience, the initiative will improve the Krispy Kreme brand in consumers' minds.

One of the company's strategic plans is to expand its franchise business, both domestically and internationally. In the third quarter, its Domestic Franchise same-store sales grew by 10.7%. It expects to open 400 domestic Krispy Kreme stores by January 2017, and considers franchises to be its main domestic unit growth driver in the next three years. Internationally, the company has around 350 shops and estimates that the total international shops could reach 900 by January 2017.

High valuation and no dividend payment
What makes me worry about Krispy Kreme is its extremely high valuation. At $19.60 per share, the company is worth 25.78 times its forward earnings. Its valuation is even higher than the valuation of the global coffee chain leader, Starbucks . Starbucks is trading at around $80 per share, with a forward earnings valuation of 25.33 (a bit lower than that of Krispy Kreme). Moreover, Starbucks' shareholders also get a 1.30% dividend yield from investing in the company. Among the three top coffee chains, Dunkin' Brands Group is the most expensively valued, with a forward earnings valuation at 26.93. However, it also offers the juiciest dividend yield, at 1.60%.

Dunkin's Brands and Starbucks' growth potential
In the future, Dunkin' Brands will target emerging markets as its main source of growth. The company estimates that those markets could account for 30%-35% of the total full-year net development. Internationally, Dunkin' Brands had 73 net new restaurants this year while the net new international restaurants of Dunkin' Donuts was 67. The store count growth was mainly driven by Europe and South East Asia. In China, Dunkin' Brands need to closed 40 restaurants in Greater China to consolidate its store base and position its business more properly before opening more stores to capture the Chinese long-term potential.

Starbucks is the largest global coffee chain, and it's continuing to expand. This is especially evident in emerging markets such as the Asia-Pacific region. In that area, Starbucks served 11 million customers every week with its 4,000 stores and nearly 70,000 partners. For the year, Starbucks had 317 new stores in China and expects to deliver result similar to last year's, where the average sales per store came out to $700,000. Starbucks expects that out of its 750 stores that will be opened in 2014 in the China and Asia-Pacific regions, China would be the main contributing factor to that growth.

My Foolish take
Through its new initiatives, Krispy Kreme Doughnuts is set to grow. However, its forward earnings valuation seems to be quite rich at the moment. Among the three companies discussed above, I like Starbucks the most because it has the lowest valuation and has a leading position with an enormous footprint in all corners of the world. Investors also receive a decent 1.30% dividend yield if they're holding Starbucks now.

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Anh HOANG 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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