The Path to Product Excellence: Avoiding Common Pitfalls and Enhancing Commun...
Case analysis krispy kreme-1
1. Case Analysis
Krispy Kreme Doughnuts, Inc.
Thadavillil (Nathan) Jithendranathan
Professor of Finance
Opus College of Business
University of St. Thomas
St. Paul, Minnesota, U.S.A.
2. Context
This case considers the sudden and very large
drop in the market value of equity for Krispy Kreme
Doughnuts, Inc., associated with a series of
announcements made in 2004. Those
announcements caused investors to revise their
expectations about the future growth of Krispy
Kreme, which had been one of the most rapidly
growing American corporations in the new
millennium.
3. Objective
• To gradually gain back analysts’,
investors’ and lenders’ confidence in the
company in the succeeding months.
• To increase sales and profitability in terms
of its core business, which is selling
doughnuts.
• To increase stock price to the previous
levels and thereby increase shareholder
value.
4. Objectives (continued)
• To correct inaccurate entries in the financial
statements and to present a clean and unbiased
report.
• To extend further reach to consumers
strategically to achieve significant growth in the
next five years.
• To implement extensive marketing measures for
its brand and products and investment strategy
for both on and off premise operations.
5. Background
• Fortune magazine had dubbed Krispy Kreme Doughnut, Inc.
“the hottest brand in America,” with ambitious plans to open
500 doughnut shops over the first half of the decade.
• The company generated revenues through four primary
sources: on-premise retail sales at company owned stores
(27% of revenues), off-premises sales to grocery and
convenience stores (40%); manufacturing and distribution of
product mix and machinery (29%); and franchise royalties and
fees (4%).
• Roughly 60% of sales at a Krispy Kreme store were derived
from the company’s signature product, the glazed doughnut.
6. Background (continued)
• On May 7, 2004, Krispy Kreme announced adverse results. The
company told investors to expect earnings to be 10% lower than
anticipated, claiming that the recent low-carbohydrate diet trend in
the United States had hurt wholesale and retail sales.
• The company also said it planned to divest Montana Mills and would
take a charge of $35million to $40 million.
• According to the Wall Street Journal, the company recorded the
interest paid by the franchisees as interest income and, thus, as
immediate profit; however, the company booked the purchase cost
of the franchise as an intangible asset which the company did not
amortize.
• Only 25% of the analysts were recommending the company as a
buy; 50% had downgraded to a hold.
7. Analysis
Growth
• Rapid growth in revenues and earnings over the
past five years.
• Significant asset growth in the past five years.
• The bulk of this growth, however, has occurred
in accounts receivables from affiliates and from
reacquired franchise rights.
9. Liquidity, Leverage, and
Profitability
• The firm’s liquidity ratios are strong and continued to
improve over the five-year period.
• The leverage ratios show that the firm has been
increasing its proportion of debt, but the balance sheet
also indicates that the firm’s level of equity has been
increasing as well.
• Times interest earned has dropped dramatically (from
124 in 2002 to 23 in 2004) as a result of a material
increase in debt.
• The stagnant returns on equity, relative to the improving
profit margins, appear to be a significant issue.
10. Peer Comparisons
• Krispy Kreme is significantly more liquid, turns its
receivables and inventory more slowly, and has less
financial leverage than its peers.
• Krispy Kreme has significantly more receivables and
intangibles, higher operating expenses, but better profit
margins than its peers.
• Krispy Kreme is growing aggressively, extending
substantial credit to its affiliates, amassing large
unamortized assets on its balance sheet in the form of
reacquired franchise rights, and yet remaining profitable
and competitive with its peers.
11. Causes for concern
• Investors are concerned about the future
earning capacity of the firm.
• There is evidence of weak management,
which led to lack of internal controls.
• CEO’s salary is 20 percent higher than the
median of companies of similar size.
• The turnover in senior management.
12. Strategies for gaining investor
confidence
• Reduce the number of new store
openings. This will reduce the saturation of
the market, which will reduce the
profitability.
• Stop pushing debt to franchises, which will
reduce the conflict of interest between the
management and the franchises.
• Revert back to more conservative
accounting practices.
