Tim Hortons’ comeback this year has made the company’s shares some of the most expensive among Canadian retail and restaurant stocks. Dunkin’ Brands Group, a U.S. competitor, trades at even higher multiples of earnings.
But the priciest doughnut stock in North America? For that, we must travel to the tobacco town of Winston-Salem, N.C., headquarters of Krispy Kreme Doughnut Corp. Up nearly 140 per cent this year, the shares, at just over $22 (U.S.), now trade at roughly 50 times forward earnings.
That’s in large part because the company – which reports results after the market closes Thursday – seems to be doing just about everything right. Its powerful gains in sales and its widening profitability help to explain why Krispy Kreme has accomplished the rare feat of becoming a major growth story for the second time.
The second time? The company would probably prefer we not bring up history, but Krispy Kreme was one of the more spectacular flameouts of the early 2000s. The stock rose eightfold in the first two years after its IPO in 2000, with Fortune magazine dubbing it “America’s hottest brand” in a cover story that compared it with Coca-Cola and McDonald’s.
Alas, an accounting scandal, lawsuits and investigations, liquidity problems, and a severe retrenchment of the business followed. Investors and Wall Street sometimes do have long memories, and the company attracted little analyst attention for many years.
That began to change in 2010, as Krispy Kreme approached profitability for the first time in six years, thanks to a restructuring program that closed unprofitable locations. In August of that year, I profiled the company in the pages of Globe Investor as the stock traded below $4.
At that time, the company had reported positive same-store sales growth – revenue gain from locations open at least a year – for six consecutive quarters. Now, the streak is at 18 quarters, and the first quarter’s 11.4-per-cent growth in same-store sales is one of the top figures in all of the North American restaurant industry. Traffic is increasing, and each customer is spending more, suggesting the chain’s forays into higher-end coffees and beverages are meeting with success.
Analyst Anton Brenner of Roth Capital Partners says the chain’s “four-wall restaurant profit margins,” a figure that leaves out headquarters expenses to examine what’s happening at the store level, have grown from 7.7 per cent in fiscal 2011 to 11.2 per cent in fiscal 2013, which ended in January. In the company’s most recent quarter, the figure was 15.2 per cent.
Part of the reason, he says, is a “rationalization” of Krispy Kreme’s “off-premise” business, in which a portion of a store’s doughnuts are shipped out to local grocery stores and other vendors. The company has been cutting the number of off-premise locations it serves, but revenue for the off-premise business is increasing, suggesting the company is figuring out which of its customers are most profitable. “The wholesale business previously was a major drain on profits, but we believe that it now contributes positively to store profitability,” Mr. Brenner says.
Mr. Brenner has been a bull for quite some time and was one of just two analysts following the company in June, 2010. The shares back then were $3.40 and the company’s forward price-earnings was a mere 17. He’s maintained his “buy” recommendation ever since, and currently has a $26 target price.
Haven’t we seen this movie, and its sad ending, before? This time, dare I say, it’s different. In its first go-round as a growth stock, Krispy Kreme’s success reflected its ability to promote its story more than its ability to run a company – at least a company that cared about execution and consistent profitability.
Now, Krispy Kreme’s new, smaller store design will make additional locations more profitable at lower per-unit sales levels. Mr. Brenner says he’s looking for “an acceleration in domestic expansion,” with new territories in the United States and internationally coming soon. The U.S. store count, above 400 a decade ago, is just over 200 now, giving Krispy Kreme a chance to do it right this time.
Of course, at the current gaudy multiples, any misstep could cause the shares to drop sharply, making Krispy Kreme appropriate only for the most aggressive of investors. However, those who don’t mind a dose of risk should take a cue from the signs the company lights when its doughnuts are fresh off the line: “Hot Now.” This stock could stay hot for a while.