Seeking Alpha
Long/short equity, special situations, value
Profile| Send Message| ()  

Shares of Krispy Kreme Doughnuts (KKD) witnessed a massive rally following the release of its first quarter earnings report for its fiscal year of 2014.

While the company is finally managing to grow the business again after a lost decade, investors have gotten ahead of themselves, pushing the value of the company up too much to consider taking a long position.

First Quarter Results

Krispy Kreme Doughnuts generated first quarter revenues of $120.6 million, up 11.2% on the year before. Growth was entirely driven by a 11.4% increase in comparable store sales. Revenues came in ahead of consensus estimates of $117 million.

Adjusted net income rose by 37% to $14.1 million, coming in at $0.20 per share. Net income rose by a third to $8.0 million, coming in at $0.11 per share. Adjusted earnings comfortably beat consensus estimates of $0.17 per share.

CEO and Chairman James H. Morgan commented on the first quarter performance, "Our exceptional performance in the first quarter is a testament to both the strength of our brand and the dedication of our team members and franchisees worldwide. It is also evidence of our ongoing momentum which we believe will make this another outstanding year at Krispy Kreme. "

Looking Into The Results

As mentioned before, sales growth was entirely driven by an increase in comparable store sales. Krispy Kreme reported its 18th consecutive quarter of same store sales increases in a row. Growth was mainly driven by an increase in traffic as pricing was up 3% on the year.

Direct operating expenses fell by 170 basis points to 80.0% of total revenues. The company actually managed to lower the dollar amount of selling and general expenses which fell a 100 basis points to 5.0%.

Looking Ahead

Based on the strong first quarter, the company is increasingly positive for the remainder of the year.

Full year adjusted income is expected to come in between $42 and $45 million after the company upped the guided range by $5 million. Adjusted earnings per share are expected to come in between $0.59 and $0.63.

On average analysts expected the company to guide for full year adjusted earnings of $0.55 per share.

Valuation

Krispy Kreme ended its first quarter with $74.7 million in cash and equivalents. The company operates with $24.1 million in short and long term debt for a net cash position of $50 million.

Based on the first quarter developments and future growth assumptions, full year revenues could come in around $480 million.

Trading around $17 per share, the market values Krispy Kreme Doughnuts at $1.10 billion. This values operating assets of the firm at $1.05 billion, or 2.2 times this year's expected annual revenues and 24 times adjusted earnings.

The company does not pay a dividend at the moment.

Some Historical Perspective

Long term holders of the shares have seen poor returns. Over the past decade investors have lost roughly half of their value. Shares peaked at $50 in 2003 and have fallen to lows of $1 in 2009.

From that point in time, shares have risen to almost $10 per share at the end of 2012. After witnessing returns of almost 80% year to date, shares are currently exchanging hands at $17 per share.

The reason behind the recovery is the improvement in operating results. Between 2010 and 2013, Krispy Kreme reported a cumulative 25% increase in annual revenues coming in at $436 million over the past year. Profitability improved in the meantime as well.

Investment Thesis

Investors are applauding the renewed growth at the company after a decade long demise. The strong first quarter momentum continued into the first three weeks of the second quarter, during which comparable sales rose by 11%. The strong results allow the company to re-gain some of the lost ground from Dunkin Brands Group (DNKN) and Starbucks (SBUX).

The recovery is mainly to thank to strong beverage sales which were up 16% in the first quarter, while volumes were up by 5% as consumers switched to more expensive coffee beverages. This development has boosted the average check per visit to $7.33 per customer.

The company only just got started with expanding its store base. Krispy Kreme ended its first quarter with 241 domestic stores, 532 international stores for a total of 773 stores. The company opened 1 domestic store over the quarter and 27 internationally. The company still aims for 400 domestic stores and 900 international stores at the start of the calendar year of 2017.

Investors which anticipated the rejuvenation of Krispy Kreme have seen incredible returns in recent years. Over the past six months alone, shares have already doubled. After years of stagnation the firm has finally started to grow again, as new store openings and strong comparable store sales provide investors with a double growth story.

While I appreciate the recovery, I think the market has been overly enthusiastic. Valued at 24 times 2014's annual adjusted earnings, the market is overshooting to the optimistic side. For those holding shares, current levels provide an excellent moment to take profits of the table.

At these levels the risk reward situation is not favorable for investors contemplating a long position.

Source: Krispy Kreme Doughnuts - Investors Become Irrationally Optimistic About The Future