As part of its expansion plans, the company aims to boost sales at Walmart, Target, Kroger, and convenience stores.
News Analysis
Krispy Kreme had a tough week on Wall Street, with its shares losing almost a third of their value due to disappointing revenues and earnings and news that it was pausing its partnership with McDonald’s.
On May 8, the innovative doughnut maker reported a loss of $0.05 per share on $375.2 million in revenue, with the former beating market expectations of a $0.06 loss per share, and the latter falling short of the expected $381.2 million, according to Zacks.
Sales declines were led by a 20.1 percent drop in U.S. sales, primarily due to a $64.3 million reduction related to the sale of a majority stake in Insomnia Cookies.
International sales didn’t fare better, down about 4.1 percent, primarily due to $8.4 million in foreign currency translation impacts.
Management tried to make these disappointing numbers more palatable by emphasizing the company’s balance sheet improvements and efforts to allocate capital more effectively in a challenging macroeconomic environment.
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“Our ability to become a bigger Krispy Kreme requires that we become better, and we are taking swift and decisive action to pay down debt, de-leverage the balance sheet, and drive sustainable, profitable growth,” CEO Josh Charlesworth said in a statement.
“While we expect the macro environment to remain challenging, we are focused on positive cash flow, higher returns on capital, and our two biggest opportunities: profitable U.S. expansion and capital-light international franchise growth.”
During the earnings call, Charlesworth provided further insight into the company’s expansion plans, including reaching its long-term goal of 100,000 points of access in the United States and capital-light international franchise growth.
As part of the plans, the company will increase its sales at Walmart, Target, Kroger, and convenience stores while eliminating unprofitable sales channels and pausing its six-month-old partnership with McDonald’s.
“Six months after the national rollout began, we’re now in more than 2,400 restaurants,” Charlesworth said.
“Our two companies have partnered closely during this time to support execution, marketing, training, and delivering a great consumer experience. We are pleased with many aspects of the program. However, we are seeing that after the initial marketing launch, demand drops below our expectations, requiring intervention.”
While management is trying to expand sales channels, it prioritizes paying down debt and pursuing only profitable growth based on sustainable revenue streams.
“We’re taking immediate actions to improve our financial flexibility and strengthen our balance sheet so that we can deliver positive cash flow, profitable growth, and create shareholder value,” said Jeremiah Ishukian, chief financial officer. “We have a clear plan with actions already underway.”
Thus far, the company has been eroding shareholder value, as its investment returns are far below the cost of raising capital. According to Gurufocus.com estimates, the company’s Return on Invested Capital (ROIC) is -0.05, far below the cost of capital of 4.42 percent, with the gap rising over time.
That means the company has yet to develop the right business model, unlike its close competitor, Dunkin Donuts.
Dunkin Brands and Krispy Kreme are in the same business, at least in the early days when the latter rolled out its doughnut factory stores, selling coffee side by side with doughnuts.
However, there was a significant difference in the way the value proposition of the two brands was arranged and promoted: Dunkin Brands sold coffee and doughnuts, while Krispy Kreme sold doughnuts and coffee.
Dunkin Brands used coffee to attract customers and eventually sold coffee and doughnuts. Krispy Kreme used doughnuts (sold mainly by the dozen) to attract customers and eventually sold both.
Dunkin’s strategy is more effective than the doughnut-first strategy, as people who drink coffee in the morning usually think about breakfast first, then something to accompany it.
In addition, for most people concerned about obesity and cholesterol, doughnuts are hardly the best food to seek. They are less likely to stop by a doughnut place, as reason prevails over emotion. But when the same people stop in a coffee place, they may buy a doughnut to go with the coffee, as emotion takes over reason.
Dunkin Brands didn’t get its business model right from the very beginning.
When the first doughnut stores opened in the 1950s, the focus was on doughnuts, sold by the dozens, rather than on coffee. As a result, the company lost business to competing local coffee shops and eventually to McDonald’s and Starbucks.
Only in the 1990s did the company shift from the doughnut-first to the coffee-first model, and the business took off.
Krispy Kreme has been changing its business model too, moving away from the direct-vertical model that makes and sells doughnuts and coffee to go to an indirect model that sells doughnuts through points of sale in supermarkets, “cabinets” within stores and partnerships such as the one it formed with McDonald’s six months ago.
However, Wall Street has yet to be convinced that the company has developed the right model to enhance shareholder value. Krispy Kreme’s shares were down 36.66 percent for the week to close at $2.73 on May 9. The stock has dropped 83.25 percent over the past five years, during which the S&P 500 index has been up 93.18 percent.
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