Krispy Kreme Doughnuts“It aint just the doughnuts that are glazed!”甜甜圈“不僅僅是上釉的甜甜圈！”

KrispyKremeDoughnuts“Itain’tjustthedoughnutsthatareglazed!”MattGnauLeslieLeeYvesdeParsevalBharatPoddarAccounting712,Section3April15,2003PAGE81.BusinessStrategyKrispyKremeisabrandedpremiumqualitydoughnutretailer.Ithasthreesourcesofrevenue.On-andoff-premisesalesfrom99companyownedandoperateddoughnutstores.Off-premisesalesconstitutedoughnutsalestosupermarkets,gasstations,etc.Royaltiesfromfranchisees(3%royalty,57stores)andareadevelopers(4.5%royalty,120stores)Salesofdoughnutmixesanddoughnut-makingequipmenttofranchiseesandareadevelopersthroughKrispyKremeManufacturingandDistribution(KKM&D)commissariesIndustryandCompetition:KrispyKremeservesprimarilyinthedoughnutindustry(asubsetofSICCode5812).It’sahighlyfragmentedindustrycharacterizedbylow-volumeoutletswithundifferentiatedproductquality.KrispyKremecompetesprimarilyonitsquality,brandanduniquewayofmanufacturingandsellingdoughnutson-premise.Itscompetitorsincludenation-widecompanies,likeDunkin’DonutsandAFCEnterprises[AFCE](Cinnabon,Seattle’sBestCoffee,Popeye’s),andmanyregionalcompanies.Asecondarymarketisthepackageddoughnutmarket(asubsetofSICCode2051).KrispyKreme’ssecondarymarketisaresultofitsoff-premisesales,whichareusedtoextenditsbrandequityandsalesinsupermarkets.CompetitorsincludeInterstateBakeries[IBC](Hostess,DollyMadison,Drake),McKeeFoods(LittleDebbie),andTastyBaking(DutchMill,Tastykake).Growthstrategy:Primarilyplanstogrowthroughnewstoreexpansionbyareadevelopers(particularlyinmarketsover100,000households)andbyacquiringequitypositionsinselectedfranchiseebusinesses.Areadevelopers’havecontractualobligationtoopen200storesbetweentheyears2003and2006.KrispyKremealsoplanstoincreasesalesthroughcomplementaryproductssuchascoffeeandbreadofferings.Thecompanyisfollowinganacquisitionstrategytoentertheseproductcategoriesandleverageitscorecompetenceinbrandingandinnovativelysellinghotproductson-premise.Furthermore,KrispyKremeisintroducingmodularHotDoughnutMachine,whichwillallowittoopensmallsatelliteretailoutletswithlowcapitalexpenditure.Finally,itplanstogointernationalinAustralia,Japan,SouthKorea,andtheUK.KeySuccessFactor:SuccesswillbeverymuchdrivenbasedonwhetherthesenewstorescontinuetogeneratethecrowdsthatrecentKrispyKremegrandopeningshavedrawnalongwiththeirabilitytoretainthosecrowdsintothefuture.MainRisks:KrispyKremedoughnut“fad”andcorresponding“premium”mayreducethroughtimeasthebrandbecomesubiquitousthroughchannelflooding.Competitionmayarisefromunforeseenotherbrandleaders,likeStarbucks,onceKrispyKremetriestoentercoffeeandbreadproductcategories.Modulardoughnutmakingmachinestillbeingtestedandmaynotsucceed.2.AccountingAnalysisUponanalysis,wefindnounusualaccountingmeasuresbeingtakenbyKrispyKreme.Ofnote,thereisadifferentbehaviorbetweenCashFlowfromOperations(CFO)andNetIncomeNI)asshownonthegraphinExhibit1.CFOflattensoutbetween2001and2002,whereasNIcontinuesonastraightlineupwards.eVal2alsonoticesthisdecreasingearningsquality.Tworeasonsexplainthisphenomenon.First,theaveragenumberofdaystopaypayableswentfrom21daysin1999downto12daysin2002.Ontheotherhand,theaveragedaystocollectreceivableswentfrom25to22daysinthesameperiod.Itseemsthatthecompanypaysalotmorequicklythanitcollects,whichisnotsustainable,unlessKKDisabletocollectmuchmoreeachtimethanitpaysouttoitscreditorsorfinancesitusingdebtorotherexternalfinancing.Second,thesalesmixhasbeenevolvingsuchthatitwasmoredifficulttodecreasetheaveragenumberofdaystocollectreceivables:Off-premisesalesfromcompanyownedstoreshaveincreasedalotmorethanon-premisesales.(Off-premisesalesincludelongerandmorevariablereceivablesrecoverydurations.)Franchiserevenueshaveseenthesamephenomenon(off-premisevs.on-premisesales).Franchisepaymentsalsoincludelongertermsofpayment(30-35days)andhaveincreasedslightlyinrelativeterms.KKM&Dsales,whichincludethelargestnumberofdaystocollectreceivables(30to54days),haveincreasedsignificantlyinrelativeproportiontototalsalesasshowninExhibit2.3.FinancialAnalysisGrowthRate:KKD’sgrowthratehasrangedfrom22-37%duringthesameperiodthatitssustainablegrowthrategrewfrom9%to17%,implyingthatKKDwouldrequireoutsidefinancinginordertocontinueitstargeted30%growthrate.Beingonlyslightlylevered,itmaybeabletofinanceitsgrowththroughissuanceofdebt.Cashflowsarepositiveandincreasingyearoveryear,thoughcashflowstoinvestorsremainnegative,notanunusualoccurrenceforagrowingcompany.PeerComparison:WechosetocompareKKD’sperformanceagainstthoseofInterstateBakeriesCorp(IBC)andAFCEnterprises(AFCE).Bothofthesecompaniesoperateinrestaurantindustryandsellbaked-andpre-madegoods.WewereunabletoconsiderAlliedDomecq(AED),operatorofDunkinDonuts,becauseusabledatawasnotavailable.Inanycase,AED’sproductlinesincludeliquorandspiritsinadditiontodonutsandwouldnothaveservedasabettercomparisonthanIBCorAFCE.DupontAnalysis:Adecompositionofthree-yearDupontaveragesbasedonactual1999-2001resultsrevealsthefollowing:KKDhasthehighestassetturnoverratiobutthelowestRNOAofthethreecompanies.Asconfirmedbythegrossmarginanalysis,KKDhasmuchlowermarginsthaneitherAFCEorIBC,implyingitispositionedmoreasahigh-turnover,low-marginplayerthanapremiumone.BothIBCandAFCEaremuchmorehighlyleveredthanKKD,whichalsohasthelowestNBC.Duringthethree-yearperiod,IBCincreasedleveragewhileAFCEdecreaseditsdebt.Asaresult,IBC’sandAFCE’sROEsbetterthantwicethatofKKD.IfKKDisabletosustainitsgrowththroughleverage,itmayalsobeabletoreachitsstatedtargetROEof20%.ChartsinExhibit3showthethree-yearaveragesofkeyratiosforthethreecompaniesindetail.P/EandP/BRatioAnalysis:KKD’sP/EandP/Band58and7.1respectivelyaremuchhigherthanthepeergroup(8.8and1.9),implyingthatthemarketviewsKKDnotonlyasagrowthcompany,butalsoasaprofitableone.However,ouranalysisdoesnotsupportthisoutlook.Whileweagreeitisgoingtogrow,wedonotbelieveitisgoingtobeahugelyprofitablegrowth.DefaultAnalysis:Alowdebttocapitalratioof14%,EBITInterestCoverageof38,andEBITDAInterestCoverageof45impliesalowdefaultprobabilityforKrispyKreme,makingitaninvestmentgradestock.4.Forecasting:OurforecastsarebasedheavilyonKrispyKreme’s10K,AnnualReports,andpressreleases.Weconsideredotherindustrycomparables,however,thehighlyfragmentedindustrydoesnothaveagoodpublicequivalenttoKKD.Therefore,wecreatedtwosalesforecastmodelsinordertogaugetheaccuracyofeachanddeterminethesensitivityofourforecasts.OurFebruary2003forecastisbasedonthreequartersofreleaseddataplusaQ4conferencecallheldinMarch2003.Thisdataispro-formaandnoGAAPreportshaveyetbeenfiledfortheyear.February2003servesasouranchorforourforecasts.IncomeStatement:(Exhibit4)SalesGrowthandCOGS/Sales:Ourprimarysalesmodelstartsatthisanchorpointin2003andrampssalesgrowthdownlinearlyto4%intheterminalyear.WethenforecastedCOGSbyanalyzingtheCOGStrendoverthepastthreeyearsineachofKKD’sthreebusinessunitsandforecastedoperatingexpensestoreduce,buttaperoff,overthecourseofthenexttenyearsineachbusinessunit.TheoverallcompanyCOGSistheweightedaverageoftheCOGSofallbusinessunits.Weightsarebasedontheproportionoftotalsalesdollarsforeachbusinessunit.ThisforecastcanbeseeninExhibit5.Inthisscenario,salesgrowthis24.6%in2003,salesmaypeekat$1.8billionandCOGSmayebbat77.4%in2013.Inanefforttogaugetheaccuracyofourprimarysalesmodel,webuiltasecondmodelthatwasbasedonourexpectationsoffuturestoreopeningsandfuturestoresalesgrowth.Webasedouranalysisoninformationfromthe10K,AnnualReport,andpressreleases.Someofthekeyinformationpointswere:Overallmarketpotentialisover650storesintheUnitedStatesreachedby2013.Areafranchiseesarecontractuallyobligatedtobuild200morestoresinthenextfouryears.Worldwideexpansionwillbemuchless(33stores).Therefore,ourfirstassumptionwasforecastingnewstoresoverthecourseofthenexttenyears.Theotherassumptionmadeinthismodelwasthepercentincreaseinrevenueperstore.Theproblemthatquicklyappearedwiththismodelwasthatinordertomakethe2003figuresmatchreportedproformanumbers,wehadtoassume–9%growthincompanyownedrevenuein2003.Thismadeitdifficulttoforecastagrowthtrendgoingforward.Webelievethatcompany-storegrowthwillreboundbutseesmallgrowth.Franchiserevenuewillcontinuetoexperiencemoderategrowth,especiallyoverthenextfouryearsduringconstructionofnewstores.Yet,KKM&Dwillexperienceareductioninitsrevenuegrowthrateasfranchisees’contractswithKKM&Dwillexpireattheendoffiscal2003andfranchiseeswillbegiventheopportunitytoreconsiderwhoitchoosestouseasasupplier.Thisrevenuegrowthrateforecastandnumberofnewstoresopenedallowsustoforecastsalesforeachbusinessline.Wecandeterminethepercentageofsalesineachbusinesslinerelativetototalsales.Furthermore,weforecastCOGStocontinuetodecreaseslightly.TheforecastscanbeseeninExhibit6.Inthiscase,salesmaypeekat$1.4billionin2013andCOGSmayebbto75%in2011.Exhibit7showsacomparisonofthegrossprofitforecastsfromourtwosalesmodels,whichareverycloseparticularlyoverthenextfirstfiveyears.Becausethefirmissupposedlyovervalued,weoptedtousethemoreoptimisticmodelinordertoidentifythemostoptimisticpossiblepricepershare.TheremainderofourIncomeStatementisforecastedasfollows.WeexpectSG&Atoincreaserelativetosalesasthecompanycontinuestogrowlarger.DepreciationandAmortizationis6.1%in2003basedontheQ4conferencecallandweexpectittoincreaseovertimebackuptowardsKKD’spreviousyears’Depreciation&Amortization.InterestExpense/AverageDebtis4.5%in2003andscaleddownto2.6%overthecourseof10years,bringingitbackonparwithpre-2003numbers.Non-OperatingIncome/Salesis–2.5%in2003duetoanarbitrationsettlementand0.3%fortheremainderoftheyears(similartopre-2003figures).Weexpecttheeffectivetaxratetoremainapproximately38%althoughitincreasedto38.9%in2003.Wecomparedourforecastswithanalysts’forecasts.Evenusingourmostoptimisticforecast,weremainonorbelowparascomparedwithotherforecasts.ThiscomparisoncanbeseeninExhibit9.BalanceSheet:(Exhibit8)WekeptEndingOperatingCash/Salesaround10%basedonKKD’scurrentcashposition.Weexpectgrowthinreceivables,particularlyfromoff-premisesalesfromaccountssuchasKroger’s.Withthenewstoregrowth,weexpectmoreKroger’sandothergrocerswillbuyKrispyKremedoughnutsforresale.Althoughinventorieshaverisenin2003,weseenoreasonforthistosustain.Wescaleditbackoffto5%,similartopre-2003figures.OtherCurrentAssetsareforecastedtoremainbetween6.1%and5%.AccountsPayable/COGSremainedfairlyconstantin2003at3.9%andweremaintainedacrossthe10-yearhorizon.OtherCurrentLiabilities/Saleswere6.8%in2003andforecastedtosteadilydecreaseto4.5%,closertopre-2003figures.NetPP&E/Saleswere41.2%in2003.ThisisaresultofKrispyKreme’snewfactory,whichwilldepreciatewithotherPP&Eanddecreaseovertimetoaforecasted28.5%.WepredictInvestments/Salestoremainfairlyconstantbetween3.3%and5%.IntangiblesincreasedsubstantiallyasaresultofKrispyKreme’srecentpurchaseofMontanaMills.Weexpectintangiblestocontinuetodecreaseoverthe10-yearhorizon.Long-termDebt/TotalAssetsincreasedto10.5%in2003asaresultoftakingondebtforthepurchaseofMontanaMillsandthenewKKM&Dfactory.Long-termdebtlevelsareforecastedtoremainhighforthenextfewyearsbeforedroppingoffovertheremainderofthe10years.Finally,weexpectthedividendpayoutratiotocontinuetoincreaseupwardstoward50%asaresultoftheenormousgrowthKKDwillexperienceintheupcomingyears.ThisisbasedonareasonableROE,examiningInterstateBakeryasacomparablebecausenotrueindustrycomparableexists,andpastperformancein1998beforeKKDwentIPOandbeganitsgrowthcampaign.5.ValuationOurvaluationusingtheforecastdescribedaboveresultedinavaluationof$21.39,accordingtoeVal2’sresidualincomemodel.KrispyKreme’srecentmarketpricehashoveredaround$34,andanalysts’twelve-monthpricetargetshaverangedfrom$37to$50withamedianvalueof$40(Yahoo!Financials).Weattributethediscrepancybetweenourvaluationandthatoftheanalyststotwomainthings:First,eventhoughweattemptedtoprovideabest-casescenarioinourforecastsofKKD’sfinancialstatements,wefoundthatwewerestillmuchmoreconservativeinourforecaststhananalysts.Forexample,ThomasWieselhasforecastedCOGStodecreaseto65%ofsalesin2004,ascenariowethinkisunlikelyforKKDtoachievebasedonitsbusinessunitbreakdown.Second,someanalystshaveworkedcloselywithKKDonrecentstockissuances,whichKKDhasusedforacquisitions,andthustheyhaveastrongincentivetoprojectoptimisticpricetargets.WeattributethedifferenceinourvaluationandKKD’scurrentstockpricetosimilarreasons,mainly,anover-optimisticoutlookonKKD’sgrowthprospects.Additionally,thepresenceofa25%shortinterestsincethestock’sIPOhasbeenforcedtocoverasKKD’s,stockpricehasremainedlevelorincreased.SensitivityAnalysis:Our$21.39stockpricewasbaseduponaratherarbitrary(butoptimistic)10%costofequitycapital.Yet,a1%changeineitherdirectionchangesthestockpricedramatically,asshownbelow.WecalculatedanothervalueforKKD’scostofequitycapitalbyusingthesizemodel,assumingarisk-freerateof4.5%,andconservativelyusingKKD’scurrentmarketcapitalizationof$1.9B,whichrankedKKDinthefourthdecileandresultedinacostofequitycapitalof13.88%.WealsocalculatedthecostofequitybasedontheCAPMmodel.ThesensitivityanalysisisshowninExhibit10.Basedonourmodel,whichgivesaterminalROEvalueofabout17%,anycostofequitycapitalbelowthisamountpresupposesthatKKDwillbeabletobuildupKrispyKreme’sbrandsuchthatitwillcontinuetobeasourceofcompetitiveadvantage.OurmainintentindoingthesensitivityanalysisistoshowthatitwouldbedifficulttojustifyKKD’s$34stockpricewithoutbeinggenerousandoptimisticaboutitssustainablesalesgrowth,magnitudeofcostreduction,orcostofequity.Withinreason,wehaveusedthemostoptimisticsalesforecast,COGSforecast,costofcapital,andgrowthrates.Therefore,westandbyourpricevaluationof$21.39andconclusionthatKKDisoverpriced.

Exhibit1:CashFlowfromOperations(CFO)vs.NetIncome(NI)Exhibit2:Exhibit2:BusinessLinePortionofTotalSales%oftotalsalesin2001%oftotalsalesin2002Companyownedstores71.167.5Franchise3.13.6KKM&D25.828.9Exhibit3:AdvancedandBasicDupontModelsKey