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Shares of Krispy Kreme Doughnuts (KKD) fell an incredible 15% after the company failed to meet the high expectations for its second quarter earnings, while the full year guidance fell short of consensus estimates as well.

After a great run up so far this year, I think shares still have more risk to the downside even after Friday's sell off. I remain slightly bearish on the prospects for the stock.

Second Quarter Results

Krispy Kreme Doughnuts generated second quarter revenues of $112.7 million, up 10.4% on the year before. Consensus estimates for revenues stood at $111.9 million.

Adjusted net income rose by 17.2% to $9.6 million, with adjusted earnings coming in at $0.14 per share, thereby falling short of consensus estimates of $0.16 per share.

Net income fell from $4.9 million to $4.7 million, with earnings per share coming in unchanged at $0.07 per share.

CEO and Chairman James H. Morgan commented on the developments during the quarter, "This was an outstanding quarter for us, and results exceeded our expectations, despite unusual items that in the aggregate negatively affected our earnings by about $0.01 per adjusted share. Our dramatic same store sales gain was driven primarily through higher traffic counts as customers found more reasons to treat themselves to our unique products, while improvements in our Company Stores and Supply Chain segments drove an increase in consolidated operating margin."

Looking Into The Results

Krispy Kreme's revenues growth was driven by same store sales, which rose by 10.0% on the year before. The quarter marked the 19th consecutive quarterly increase in same store sales.

Company-owned stores showed a 9.2% increase in revenues to $75.7 million, driven by same store sales growth which on itself was driven by increased traffic as prices increased by 3.8%. The stores reported operating income of $1.8 million, compared to just $0.3 million last year.

Direct operating expenses fell by 67 basis points to 83.2% of total revenues. Margin gains were made undone by general and administrative expense which rose by 35 basis points to just over 5.0% of total sales, driven by unexpectedly higher healthcare costs for employees.

Krispy Kreme Doughnuts took another $1 million loss on the refinancing of its debt, and it lost $0.02 per share in losses on agricultural derivatives.

Looking Ahead

Krispy Kreme reaffirms its forecast for adjusted net income of $42 to $45 million for the year, with earnings per share seen between $0.59 and $0.63 per share. This implies that earnings are seen up 26 to 34% on the year before.

The company increasingly thinks that achieving the high end of the earnings guidance is achievable. Yet investors are slightly disappointed as consensus estimates stood at $0.64 per share.

Valuation

Krispy Kreme Doughnuts ended the quarter with $60.3 million in cash and equivalents. The company operates with $1.3 million in total debt, for a modest net cash position.

Revenues for the first six months of the year came in at $233.4 million, up 10.8% on the year before. GAAP net income rose by 16.1% to $12.7 million, with earnings per share coming in at $0.18 per share.

At this pace annual revenues could come in around $475 million, while earnings are expected to come in around $25 million.

Factoring in the 15% declines on Friday, the market values Krispy Kreme's at $1.3 billion. This values operating assets of the firm around $1.25 billion. As such, operating assets of the firm are valued at 2.6 times annual revenues and 50 times annual earnings.

Krispy Kreme Doughnuts does not pay a dividend at the moment.

Some Historical Perspective

After a decade long demise, shares have fallen from $50 in 2003 to lows of just $1 in 2009. Shares of Krispy Kreme have finally seen some upside in recent times, notably in 2013.

Shares have risen from merely $7 in October of last year and hit upon highs of $23 in recent weeks. After the sell-off, shares are exchanging hands just below $20, but are still trading with year to date gains of 110%.

Between the calendar year of 2009 and 2012, Krispy Kreme has increased its annual revenues by a cumulative 25% to $436 million. After breaking-even in 2009, Krispy Kreme has reported an almost $21 million profit last year.

Investment Thesis

Krispy Kreme Doughnuts has been expanding its offerings beyond sweet treats into coffee and smoothies, thereby competing to some extent with Starbucks (SBUX) and Dunkin Donuts (DNKN). It is this expansion which has fueled comparable store sales.

The company furthermore attempts to grow sales by opening smaller shops, which are profitable at lower revenue levels as they don't make the actual donuts on the spot anymore. Higher costs of international expansion have been higher than anticipated as well.

Back in June of this year I last took a look at Krispy Kreme's prospects. I thought that investors became irrationally optimistic about the future, as shares topped $17 per share at the time. Shares have risen another 35% to highs of $23 in the meantime, but have seen a 15% sell-off on Friday.

I have to reiterate my stance, and I think Friday's sell-off might be the start of a further correction after the market has overshot to the upside. The current valuation is too high, despite impressive comparable store sales results and plans for future store openings.

I have no position in the stock, but have a slightly bearish stance at the moment.

Source: Krispy Kreme Doughnuts - Friday's Correction Might Be Just The Start