A big event transpired Jan. 19 in Bangalore, India. Krispy Kreme Doughnuts (NYSE:KKD) opened its first of 80 stores planned for the next five years in partnership with Dubai-based retailer Landmark Group. Bangalore was chosen as the first location because of its welcoming attitude toward international brands; it should be the beginning of an excellent partnership. The once down-and-out doughnut shop appears to be making all the right moves these days.
Can Krispy Kreme keep the good times coming? Let's have a look.
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Who isn't familiar with the Krispy Kreme brand? Even up here in Canada where its expansion went terribly wrong, many still recognize the green and red logo due to their travels south of the border. So it's not surprising that there are 744 shops in 21 countries including India.
While the U.S. has the most stores open with 238, Saudi Arabia has 95 locations up and running, the second highest in the company. Third highest goes to Mexico with 90. Canada, regrettably, only has six locations open, but hopefully that will change. It's a nice alternative to Starbucks (Nasdaq:SBUX) and Tim Hortons (NYSE:THI). Needless to say, international expansion is a big part of its growth.
Management expects to finish fiscal 2013 (end of January) with 510 international locations, growing to 900 within four years. All will be franchised. It has development agreements in place, like the one with the Landmark Group, to open 380 stores through fiscal 2019. That means it will have to sign agreements in places where it hasn't already done so like Brazil and the rest of Latin America. It won't be easy, but with good partners possessing real QSR experience, it should happen.
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In the U.S., Krispy Kreme will finish fiscal 2013 with 240 stores and seeks to grow to 400 or more by fiscal 2017. That's 40 per year, a majority of which will be franchised. Smartly, it's staying close to home with its company-owned locations, putting most of them right in its backyard in the Southeast. On the franchise front, it will expand outside its home market into other parts of the country. Of the two goals, I see its domestic agenda as more attainable. Certainly Americans have proved their desire for coffee and doughnuts is relatively unlimited.
Last January I wrote that Krispy Kreme was focusing on opening new locations, utilizing smaller stores clustered together, reducing its debt and improving cash flow. If it stuck to some basic ideas, its future success would take care of itself. Up 72% in the past year, if it keeps up the good work, I don't see why it couldn't revisit the halcyon days of 2003 when it came within a whisker of $50 a share. Don't believe me? Consider what it's done in the past year in each of the four areas:
1. New Locations - Krispy Kreme planned to open as many as 85 stores globally in fiscal 2013. Through the first three quarters it opened 37 stores, and although it didn't mention the number of net openings for the final quarter of the year in its Q3 information, I'd expect a similar number of openings around 20, putting the total for the year at 57 stores. That's well below its initial targets. A major part of the problem in fiscal 2013 was the fact that it only hired a VP of U.S. Franchise Development Jan. 7. Now that Cindy Bay, someone with 30 years of experience, is on board, I'm sure it will pick up the pace.
2. Small Store Strategy - In its Q3 conference call, CEO James Morgan outlined why its new 110M machine and production line is critical to Krispy Kreme's success. Rolling out the machinery in as many as seven company-owned shops in 2013, they will allow for a 2,200-square-foot location instead of 3,500 or more. Easier to operate, the return on investment and most other operating metrics will be higher. Clustering becomes easier when you have smaller square footage at each location. This is an ongoing process that will transform its retail operations.
3. Debt Reduction - Although it's been chipping away at its debt the last few years, in 2012 Krispy Kreme chose to focus on repurchasing shares instead. Therefore, in the first nine months of fiscal 2013, it paid down just $1.6 million of its long-term debt. Look for it to increase that substantially in 2014.
4. Cash Flow - In the first nine months of 2012 its operating cash flow increased by 65% year-over-year to $38 million. It used much of its $28 million in free cash flow to repurchase 3.1 million of its shares at an average price of $6.42, almost doubling its money in less than a year. There will be plenty of time to pay down its $25 million in debt outstanding.
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The Bottom Line
Analysts can't raise their estimates for Krispy Kreme fast enough. I liked its stock when it was trading at half its current price last January, and I still like it now. CEO James Morgan is doing a fine job bringing the brand back to life. I expect good things to continue to happen with Morgan at the helm.
At the time of writing, Will Ashworth did not own any shares in any company mentioned in this article.
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