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False Hope From Krispy Kreme

Posted: Jun 13, 2008 08:08 AM by Glenn Curtis

Tickers in this Article: KKD, MCD, SBUX, THI

Doughnut chain Krispy Kreme (NYSE:KKD) has bled a fair amount of red ink over the past few years. That's probably why many investors were so upbeat when the North Carolina based company posted a first quarter profit. It gave hope that this turnaround stock was finally headed in the right direction. The problem with getting your hopes up is they can so easily be let down. I think that's the setup we have with Krispy Kreme right now.

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When Good Earnings Happen to Bad Companies
In the quarter ended May 4, Krispy Kreme reported a profit of $4 million (6 cents per share). That's markedly better than the loss of $7.4 million (12 cent per share) it experienced in the same period last year.

This sounds like good news, but I would argue it can cut both ways. A number in the black is always nice, but I think it could be a negative if this were to now become an earnings, as opposed to a comeback, story.

In conjunction with the press release Krispy Kreme's CEO Jim Morgan made the following comment:

"Much work remains to be done to achieve the consistent profitability and sustainable growth we envision ... Although our near term results may be uneven, our employees are working hard to implement the further improvements necessary for us to be successful for the long term."

When you read between the lines, Morgan is saying that the company could still face a bumpy road going forward. Frankly, I don't think that would be very comforting for those expecting consistent earnings.

Also, if this does become an earnings story, what might Krispy Kreme hope to earn in the near term? Keep in mind that its revenue line declined 6.6% to $103.6 million from $110.9 million last year. Plus its operating income as a percentage of revenue stood at about 5.4%. This is not promising given that rival Tim Hortons (NYSE:THI) reported an operating margin of almost 21% in its first quarter. (To read more on this concept, check out Earnings: Quality Means Everything.)

Doughnut Wars
Again, while Krispy Kreme's comeback is welcome, I would suggest that it could be facing an uphill battle in the months ahead thanks to the highly competitive operating environment.

Tim Hortons is very well known throughout Canada and is gaining a foothold in U.S. (particularly in Eastern states) as well. Timmy's, as our neighbors to the north know it, is in growth mode. During its recent first quarter, a total of 25 restaurants were opened compared to 21 in the first quarter of last year. It has also introduced several new products including the Bagel B.E.L.T. (bacon, egg, lettuce and tomato), toasted almond flavor shots, Tuscan vegetable soup and larger size gourmet cookies.

Meanwhile Starbucks (Nasdaq:SBUX) has offered deals like $1 coffee as a means of driving foot traffic, and McDonald's (NYSE:MCD) has made the push into coffee. McDonald's has plans to open coffee bars in thousands of locations. It's also been aggressively pushing its breakfast menu, which could hurt doughnut chains as well.

Bottom Line
Krispy Kreme's Q1 profit was nice to see. One could argue that because the stock is so low and no one expects much out of the company that it's a good opportunity to pick up the shares on the cheap. It's a nice theory, but I'm not sure it's worth trying to prove.

I really don't think the company wants to be an earnings story at this point, and I'm not optimistic given the competitive environment.

By Glenn Curtis

Glenn Curtis started his career in the 1990s as an equity analyst for a regional firm in New Jersey. There, he covered companies in the technology, entertainment, and gaming industries. Curtis has since worked as a financial writer at a series of both web and print publications, including TheStreet.com and Registered Rep Magazine. He has held his series 6,7,24, and 63 securities licenses.

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