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Investors see a hole in Krispy Kreme’s story

Krispy Kreme has made a resurgence since 2009, and same-store sales have grown for the past 20 quarters.

Louie Palu/The Globe and Mail

Investors are losing their craving for Krispy Kreme Doughnuts Inc. after a year of spectacularly sweet returns.

The doughnut chain's stock lost one-fifth of its value on Tuesday after the North Carolina-based company forecast earnings growth that didn't live up to Wall Street expectations.

For long-term investors, the sell-off was a reminder of an earlier collapse in Krispy Kreme shares nearly a decade ago. But despite Tuesday's drop, some believe the stock's run isn't over.

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"We would aggressively accumulate the shares on price weakness," Roth Capital Partners analyst Anton Brenner said in a note on Tuesday.

In an interview, he said Krispy Kreme's share price was ripe for a pullback.

Prior to Tuesday's close at $19.59 (U.S.) on the New York Stock Exchange, its lowest level in two months, Krispy Kreme stock had surged by about 170 per cent over the past year, rising steadily from about $9 to above $26 two weeks ago.

The losses on Tuesday bring "Krispy Kreme back to an area where it's very attractive again," said Mr. Brenner, who has a $27 target on the stock.

He is one of seven analysts with a "buy" on the stock, while two recommend it as a "hold," according to Thomson Reuters I/B/E/S.

The stock remains far off its record highs near $50, which it reached more than a decade ago. By 2003, Fortune magazine was declaring Krispy Kreme to be "America's hottest brand" and baseball legend Hank Aaron had opened a franchise in Atlanta amid much fanfare.

But the chain's drive to open new stores overwhelmed demand, especially as the anti-carbohydrate craze convinced customers that they should look for their treats elsewhere. An accounting scandal also hurt investor confidence.

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Krispy Kreme reported its first quarterly loss in 2004 and its share price kept falling, hitting a low just over $1 in February, 2009, as rumours of bankruptcy swirled.

The company responded by installing new management that cut the number and size of its stores, while stressing international expansion. Krispy Kreme has been a turnaround story ever since, reporting same-store sales growth for the past 20 quarters as profit margins continue to rise. Today, it has around 800 stores, about three-quarters of which are outside North America, and plans for 900 locations worldwide by 2017.

"We are making good on our commitments," chief executive James Morgan told investors on a call late Monday after reporting a 6.7-per-cent increase in sales to $114.2-million for the third quarter ended Nov. 3.

Stores open for more than a year grew by 3.7 per cent and earnings increased 33 per cent to 16 cents a share. Krispy Kreme also increased its full-year guidance by a penny to between 60 and 63 cent and said 2015 should be in the range of 71 to 76 cents. Still, both were below what analysts had anticipated.

While the expectations were considered by many as too high, some analysts are comfortable with the company's new lower share price.

"I feel like the valuation here is about right," said Wedbush Securities analyst Nick Setyan, who has a "hold" on the stock and a $24 price target.

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Some investors argue Krispy Kreme remains expensive compared to its peers, particularly since it depends nearly entirely on the sale of doughnuts, rather than the more diversified offerings of its rivals. Krispy Kreme trades at about 30 times earnings (down from 34 times before Tuesday's price drop). That compares to 29 times for Starbucks Corp., 26 times for Dunkin' Brands Group Inc. and 19 times for Tim Hortons Inc., according to data from Morningstar Inc.

While Krispy Kreme has been a great success story, its valuation is "way too high," says Barry Schwartz, vice-president and portfolio manager at Toronto-based Baskin Financial Services.

"We don't look at companies at 30 times earnings. Those make us queasy," he said. Instead, his company owns shares in Tim Hortons, based on the Canadian company's lower multiple and the belief that it has room for improvement.

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About the Author

Brenda Bouw is a freelance writer and editor based in Vancouver. She has more than 20 years of experience as a business reporter, including at The Globe and Mail, The Canadian Press, the Financial Post and was executive producer at BNN (formerly ROBTv). Brenda was also part of the Globe and Mail reporting team that won the 2010 National Newspaper Award for business journalism. More


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