I'm shorting Krispy Kreme today

[DesertCat]

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I notice KKD kind of cratered today. Down over 2%. Could be the start of something big. We've had small bars lately and today we had range expansion and substantial downside volatility.

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I think the market is wondering why a new CEO who just announced international expansion is KKD's big ticket, would turn around two weeks later and sell all of their UK stake. It's a small chink in the armor. Our real test is their release of financials this month. If they miss the date, or the financials look terrible, we'll be in great shape.

[Sniper]

Krispy Kreme is looking to unload its stake in a British franchisee, according to a Reuters report.

A spokeswoman for Winston-Salem-based Krispy Kreme (NYSE: KKD) told the news agency that the doughnut maker was in talks with its UK franchisee to sell its 35 percent interest in the business to the franchisee.

Over the last year, Krispy Kreme has shut down various franchisees in which it had a majority ownership stake, and sold ownership stakes in other franchisees, including some overseas.

Daryl Brewster, who took over as CEO of the troubled doughnut maker in March, has said that international opportunities are one possibility for the company's future growth.

As of this week, there are 312 stores, comprised of 124 company owned and 188 owned by franchisees. That's down from 321 in early February.

[Sniper]

Another recent article...

Krispy Kreme Stock Rises for 5th Month, Hurting 'Short Sellers'

March 21 (Bloomberg) -- Shares of Krispy Kreme Doughnuts Inc., bolstered by the appointment of a Kraft Foods Inc. official as chief executive officer, are headed for their longest monthly winning streak since 2001. The advance may prompt ``short sellers'' to scale back their bets against the company's shares.

Winston-Salem, North Carolina-based Krispy Kreme has jumped 33 percent in March, on pace for its fifth straight monthly gain, amid speculation Daryl Brewster will be able to revive sales and guide the company through accounting investigations by the Securities and Exchange Commission and federal prosecutors.

More than 48 percent of Krispy Kreme's shares available for trading were borrowed and sold in the hopes of buying back at a lower price, according to short-sale statistics from Feb. 10. The No. 2 U.S. doughnut chain is up 40 percent since then.

``I wouldn't want to be short the stock,'' said Donald Hodges, whose $447 million Dallas-based Hodges Fund has returned 22 percent annually the last five years. ``There's some huge potential here if the new management can turn it around.''

The New York and American stock exchanges will report today on short selling in U.S. stocks for March. The Nasdaq Stock Market's figures will follow on March 27.

Brewster was President of Kraft's North American Snacks & Cereals Sector, making him responsible for about $6 billion in revenue and 20,000 employees. The unit was the company's second- fastest growing business by revenue after beverages last year, helped by the removal of trans fats linked to heart disease from snacks and a focus on healthier foods.

Not as Confident

Krispy Kreme's stock surged 21 percent, its biggest rise in more than a year, on March 7 when Brewster was named to replace interim chief executive and turnaround specialist Stephen Cooper. Hodges said he bought 200,000 Krispy Kreme shares in the following week and predicted they may double in 18 months.

Some investors and analysts aren't as confident as Hodges. Krispy Kreme has not reported any earnings since Fall 2004, after the SEC first began an informal, then a formal investigation into its accounting for the repurchases of franchises. Several shareholder lawsuits followed.

The Federal probes have fueled an 82 percent plunge from a record high in 2003, along with an expansion that was too fast and trends toward low-carbohydrate diets. Former Chief Executive Scott Livengood was ousted along with six other executives last year during an internal probe that found they may have inflated earnings to beat forecasts.

Krispy Kreme has until April 30 to file a 2005 annual report with the New York Stock Exchange or it may be delisted.

`Back on Radar'

``A name worth putting back on radar, nothing more just yet,'' wrote John Glass, a New York-based analyst with CIBC World Markets, in a note to clients on March 16. The analyst, who rates Krispy Kreme `sector underperformer,' cited the delisting risk, declining annual sales and ``considerable one- time legal and accounting bills.''

Glass estimates that Krispy Kreme trades for 14 times earnings before interest, taxes, depreciation and amortization, above the ratio of 10 for the S&P Supercomposite Restaurants Index, containing 27 stocks including McDonald's Corp.

Krispy Kreme is ``not cheap enough to warrant the risk,'' Glass wrote.

[Sniper]

And another recent development...

Westward Dough expands Krispy Kreme business
3rd April 2006
By Staff Writer

Specialist coffee and snack retailer Krispy Kreme Doughnuts is to sell rights to 12 of its stores to existing development partner Westward Dough.

Westward Dough, which currently operates Krispy Kreme Doughnut stores in Utah, Idaho, Nevada, Montana and Wyoming, has reached an agreement to add operating territories to its existing development area. The new stores are located in Colorado, Wisconsin, and Minnesota. Details of the transaction were not revealed.

Westward Dough said it added the territories based on its assessment of the brand power of the Krispy Kreme Doughnuts' name and product line, its history of successfully developing and managing territories, and its forward-looking expectations of sales and revenue growth.

"Krispy Kreme Doughnuts has a strong market position and a strong continued opportunity for growth and sales enhancements," said Lincoln Spoor, owner of Westward Dough.

Founded in 1937 in Winston-Salem, North Carolina, Krispy Kreme currently operates more than 380 stores in 45 US states, Canada, Australia, Mexico, the Republic of South Korea and the UK.

Westward Dough was founded in 1996 with its first Krispy Kreme location in Las Vegas, Nevada. Westward Dough will now operate 26 stores in eight states.

[DesertCat]

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Glass estimates that Krispy Kreme trades for 14 times earnings before interest, taxes, depreciation and amortization, above the ratio of 10 for the S&P Supercomposite Restaurants Index, containing 27 stocks including McDonald's Corp.

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They haven't released any financials since August, 2004. And sames store sales and store count has declined dramatically since then. I wonder where he's getting his EBITDA estimates?

[Sniper]

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Glass estimates that Krispy Kreme trades for 14 times earnings before interest, taxes, depreciation and amortization, above the ratio of 10 for the S&P Supercomposite Restaurants Index, containing 27 stocks including McDonald's Corp.

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They haven't released any financials since August, 2004. And sames store sales and store count has declined dramatically since then. I wonder where he's getting his EBITDA estimates?

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He's paid to guesstimate... we will see how close he is if/when KKD releases financials.

[Sniper]

Cat,

Worst case, if the reported financials look better than expected, where would you put the upside on the stock?

[DesertCat]

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Cat,

Worst case, if the reported financials look better than expected, where would you put the upside on the stock?

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I can't predict price action. But I can make an educated guess at value. Assume revenues, which were on a $700M run-rate, are now around $420M due to store closing and lower same store sales. If they could make 5% after tax profit on those sales, they'd be geniuses. That would be $21M a year and at a 15 PE would make them worth around $5.

But the real bull case is that they figure out a workable business model, and same store sales shoot up as a response, and they net 8% after tax. Then sales could be $500M, profits $40M and both are growing rapidly. A 25 PE would put them at around $15. As they continue to re-open stores with this great new model, sales grow more, momentum investors get on the bandwagon, it shoots up from there.

[DesertCat]

Hmm, I'm looking at Tim Horton's prospectus, and their after tax net is almost 15%. Dunkin Donut's might have been even higher, but Allied Domecq lumped them in with Baskin Robins, and the group as a whole was around 20-25%.

KKD's peak was about 6.5%. So is the bull case a return to 6.5%, or a business model that produces Tim Horton level profits? Obviously the upside is much greater in the second case.

But I think the paucity of profits that KKD produced at it's peak (say that three times fast) is evidence of how screwed up their model is today, and how much work they have ahead of themselves.

[DesertCat]

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KKD's peak was about 6.5%. So is the bull case a return to 6.5%, or a business model that produces Tim Horton level profits? Obviously the upside is much greater in the second case.


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I forgot to mention that the 6.5% included the effects of the "fraud", so that number when restated will probably be closer to 5-6%.

And my revenue estimates may be pessimistic. Last quarter they did $130M in revenues. Since then they've closed at least 10 stores (out of 330). Depending upon how sales are declining, or stabilizing, and how many more stores they have to close, revenues should be around $500M per year.

Running it through a similar model to 2004, gives them $59M in EBITDA, or an EV/EBITDA of 12.5 today, a rich valuation. They may have more EBITDA, if they've cut G&A expenses. They are much more likely to have less because of the high restructuring costs, and a worsened revenue mix.

My current estimate of company store break even is $42k per week. As company store sales fall from $58k per week to $42k, they will no longer contribute excess cash flow. For example, a $58K a week store may contribue $16k a week as cash flow to corporate, to pay for G&A and the excess contributing to EBITDA. But a $48k per week company store can only contribute $6k a week. And that's where they were last fall. So G&A, which was $45M a year, has to be cut by 60% in response to only a 28% decline in sales in order to stay proportionate to company store contributions.

Of course I'm ignoring franchisee stores, which are more than half the stores. They contribute directly to cash flow by paying franchise fees (3% of revenues for the 56 "original stores", 4.5-6% for the 200+ new guys) and markups on product supplies and ingredients. Franchises should have a break-even over $44k per week. The problem there is that based on the sales declines, the average franchise store may already be below that. That is a reason that no new franchises are opening, and every month more close.

That brings me to their last source of cash flow, selling equipment to franchises at big markups. No new franchises, no equipment sales. In fact, if they are ever able to convince new franchisees to open, the new guys will be able to buy used equipment from the guys who went Busto! for years to come.

I'm working on a model with the specifics here, for a more realistic estimate of future EBITDA. I won't be able to model the "restructuring" fees, but should be able to come up with reasonable expectations for the business. I.e. if KKD could immediately finish restructuring and just run the existing stores going forward.