Krispy Kreme posted very solid 3QF14 results after the close yesterday and today’s dip offers a nice buying opportunity for those looking to be long the name. Despite softer than expected top-line growth, the fundamentals of our bullish thesis remain intact. In our opinion, today’s selloff was largely due to “disappointing” domestic company comps of +3.7%, which missed consensus metrix estimates of +6.7%. However, domestic franchise comps (+10.7 vs. +6.8% estimate) and international franchise comps (-3.1% vs. -7.9% estimate) both significantly surprised to the upside. Domestic company and franchise comps continue to grow and international comps are accelerating at a rate much faster than anticipated. There is a chance that international comps could turn positive next year, which would be far sooner than the street currently expects.
While KKD appears to have failed to live up to lofty expectations, the fact of the matter is the company is in great shape. All four business segments posted higher operating margins than a year ago, traffic was up +1.1% despite lapping a difficult comp of +7.1%, beverage sales were up +4.2%, the growth story is predominantly on track, and the balance sheet is as strong as ever. Essentially, the growth drivers that made us bullish on the company back in early September are still in place. Krispy Kreme has tremendous opportunities to drive long-term growth by continuing to refine its freestanding small factory shops, driving higher margin beverage sales, growing its capital light model, and expanding its domestic and international footprint.
As an aside, management did acknowledge that its original goal of 400 domestic shops by January 2017 may aggressive. This is marginally negative, but isn’t a huge deal. In fact, management would not completely rule it out and the overall growth story is largely on pace to play out. Another point of contention is the gap between domestic company (+3.7%) and domestic franchise (+10.7%) comps. To most, this signals that the company is doing something wrong. But, to us, this resembles an impressive franchise base and an opportunity to refine company operations. Seven domestic franchisees grew same-store sales by +20% or greater, while the remaining franchisees grew same-store sales by +7% or greater. This type of operational execution and performance is what makes us excited about the growth prospects of this company. KKD announced a development agreement with Dulce Restaurants, LLC, to develop 10 new shops in Houston over the next five years and management indicated that more announcements are likely to follow in the coming weeks and months.
The market’s reaction today is emblematic of what we saw last quarter after KKD reported “disappointing” 2QF14 results. KKD is currently trading at a PE of 27.5x and 17.8x EV/EBITDA on a NTM basis, well below prior valuation levels. This downward multiple revision represents a strong buying opportunity.
What we liked in 3QF14 results:
- Revenues rose +6.7%, comparable sales rose +3.7%, and operating income rose +27.2%.
- Domestic franchise and international comps blew away expectations.
- Operating margins improved across all four business segments.
- Traffic was up +1.1%, despite lapping a very difficult +7.1% comp.
- International same-store sales could turn positive next year.
- Beverage sales grew +4.2%, led by the coffee category which was up +15%.
- The wholesale channel is growing. Average weekly sales per door rose in both the grocery and mass merchant and convenient store channels.
- Long-term opportunity to drive incremental sales and extend the Krispy Kreme brand through packaged ground coffee.
- The majority of domestic unit growth over the next three years will be franchise.
- Continue to develop and improve the freestanding small factory shop models.
- Total franchise commitment for additional international development now stands at roughly 350 shops and the goal of 900 international shops by January 2017 remains achievable.
- Recently announced two franchise agreements (Alaska and Houston) and plan to announce more in the coming weeks and months.
- The growth story is intact. Anticipate opening 10 to 15 domestic company stores, 20 to 25 domestic franchise stores and about 85 international franchise stores in FY15.
- KKD is now much more attractive from a valuation standpoint.
What we didn’t like in 3QF14 results:
- Total revenues came in light, driven by disappointing domestic company comps (+3.7% vs. +6.7% estimate).
- Management sounded unsure that they would be able to hit the original goal of 400 domestic stores by 2017, calling it a “stretch” goal.
- Facing difficult domestic company and franchise same-store sales comparisons in 1HF15.
- Preliminary FY15 EPS guidance of $0.71-0.76 came in below expectations of $0.77.
Howard Penney
Managing Director
