Initial Report: Krispy Kreme (DNUT), 56% 5-yr Potential Upside (EIP, Chengjia LEE)
Is the stock as delicious as its donuts? Chengjia seems to think so! Let's enjoy this read over a cup of coffee and Kripsy Kreme...
LinkedIn | Chengjia LEE
EXECUTIVE SUMMARY
DUNT is an established and market leader in the doughnuts and coffee industry located in U.S that is looking to take advantage of the ever-increasing demand for baked goods and coffee. By utilizing their spoke and hub model, it is likely that DUNT will be able to expand its reach to customers worldwide without huge expenditures despite their less than stable financial position.
As such, the company is looking likely to continue growing and increasing their revenue, abet at a slower and steady rate due to their focus in strengthening their unrealized potential in the domestic first. Assuming they are able to ride on the CAGR of 10% growth for their doughnuts and maintain their position of market share in the coffee industry, using DCF, a target price of USD20.00, a 36% upside is generated as a 3 Y target price.
Company Overview
DNUT produces and distributes doughnuts. It offers various packaged and unpackaged doughnuts, pies, coffees and espresso drinks, chillers and iced beverages. The company owns and franchises Krispy Kreme Stores. It operates through the following segments: US and Canada, International and Market Development.
The U.S. and Canada segment includes all Krispy Kreme’s company -owned operations in U.S. and Canada, Insomnia-branded retail shops and consumer packaged goods operations. The international segment consists of all Krispy Kreme’s company-owned operations in the United Kingdom, Ireland, Australia, New Zealand and Mexico. The market development segment handles the franchise operations (reflecting royalties collected) across the globe, as well as Krispy Kreme company-owned shops in Japan. The firm sells its products through mass merchant, grocery and convenience stores.
The company operates a Hub and Spoke Distribution model. the company operated 8,583 DFD doors (Spokes) and 1,810 shops of which 1,218 are Fresh Shops, 382 are Hot Light Theatres Shops (Hub), and 210 are Cookie shops. As of January 2, 2022, the Company had 1,810 Krispy Kreme and Insomnia Cookies branded shops in over 30 countries around the world.
The company reported revenues of (USD) US$1,529.9 million for the fiscal year ended January 2022 (FY2022), an increase of 10.5% over FY2021. In FY2022, the company's operating margin was 1.9%, compared to an operating margin of 3% in FY2021. The net loss of the company was US$15.6 million in FY2022, compared to a net loss of USD$24.5 million in FY2021.
Revenue Drivers
The net revenue growth was driven by growth strategy and transformation of deploying their omni-channel approach globally.
The U.S and Canada’s fiscal 2022 revenue of US$1,033.1 million and consisted of In Shop / Drive-through, E Commerce and Delivery DFD (Delivered Fresh Daily) and Branded Sweet Treat line. The product offerings are branded into KK Fresh Hub and Spoke, Branded Sweet Treat Line and Insomnia Cookies.
The International Segment’s fiscal 2022 revenue of US$365.9 million and consisted of In Shop / Drive-through, Ecommerce and Delivery and DFD.
The Market Development’s fiscal 2022 revenue of US$130.9 million consisted of Japan, U.S. and Canada Franchise and International Franchises.
Cost Drivers
For cost drivers, the top 3 costs are their product and distribution costs, operating expenses as well as Selling, general and administrative expenses.
In terms of Product and distribution costs, it increased by US$ 52.1 million or 14.7% from the previous fiscal year driven by inflationary pressures on commodities and logistics costs as well as increased promotional activity in the U.S and Canada.
For operating expenses, it increased by US$74 million or 11.7% driven mainly by labour costs inflation and investments to support growth.
The last cost driver: Selling, general and administrative expense, increased by US$0.8 million or 0.4%. Despite that, SG&A decreased as a percentage of revenue due to decrease in advisory service fees as they completed their Re-IPO from 2021. The decrease was also due to lower share-based compensation expenses, as well as economies of scale from their top-line revenue growth.
Corporate Strategy
DNUT’s growth strategy concentrates on expanding to more grocery and convenience stores and adding more doughnut shops in both existing and new countries.
The company in FY2022 has opened several shops across the geographies. It opened its first branch in Dublin city, Ireland in August 2022. It aims to increase growth in sales and profitability by increasing trial and frequency, fresh points of access and driving additional efficiency benefits from its omni-channel execution.
Investment Analysis
Strengths
Franchisee Operations:
Operated 839 franchise shops including 66 in US and Canada and 773 Krispy Kreme International
Partnered with several leading companies in food and beverage. Plans to expand licensing of its brand to additional beverages and other product categories.
Operational Network:
Strong network helps to serve huge customer base, ensuring strong top line performance.
Geographically diverse operations help the company to mitigate various risks associated with overdependence on a particular market.
Owns a manufacturing facility in North Carolina which incorporates doughnut mixing plant and distribution centre. This is in addition of the 4 doughnut factories around US and 38 internationally, of which 25 are operated by franchisees.
Strong Revenue Growth:
Following growth of 10.5% in FY2022, the generated revenue of US$1,384.4 million as against US$1,122 million in FY2020, with an annual growth of 23.4%
Revenue grew at a CAGR of 20.1% during 2019-2021
InvestmentThesis: Hub & Spoke Strategy to improve capital efficiency
Hub & Spoke Strategy will significantly improve margins
Under H&S model, DNUT’s legacy stores in the US aren’t as much restaurants as they are miniature factories.
Due to this , the potential returns of this strategy is higher as the CAPEX required to turn it into such Hubs are only coming from the equipment required. (US$2-4 million)
This model is a better way to monetize legacy infrastructure that has largely been built out, reducing heavy debt and CAPEX expenditure
There is still potential for growth within US (Hubs without spokes in the United States grew at a pace of 5% below hubs with spokes in previous quarter).
There are still 118 stores in the United States that are hubs without spokes, showing there are still potential stores and markets to reach out to with this model, increasing revenue with better margins.
Investment Thesis: Product Market Growth
Global Bakery and Cereals Market
DUNT is the leading manufacturer of bakery and sweets products and has an estimated 6.5% of total industry revenue.
With growth in the worldwide bakery market past 2 years, the global bakery and cereal market is forecasted at a value of US$735,302.2 million in 2025. Bread and rolls was the largest segment (33.8%), followed by cakes, pastries and sweet pies (19.3%) and cookies (11.8%)
Geography wise, Europe accounted for 34.5% of the global bakery and cereal market value, followed by Asia-Pacific (24.1%) and US (21.6%).
Hypermarkets and supermarkets formed the leading distribution channel, accounting for 39.4% of the market and convenience stores (17.2%)
Krispy Kreme is a prime position to leverage across the market due to their leading position in product offerings, their distribution channels where they deliver to DFD shops which provides additional access in grocery & convenience stores as well as Fresh Shops (capital-light Fresh Retail) at convenience retail locations.
Hot Drinks Market
Revenue in the Hot Drinks market amounts to US$672.36 million in 2022, market is expected to grow annually by 4.39% to US$ 831,600 million by 2025
The largest segment in the market is Coffee with a market volume of US$495,500 million in 2023.
DUNT offers beverages such as coffee roasts, brewed coffee , hot chocolates and chillers.
By 2025, 73% of spending and 12 % volume consumption will be out of home consumption, while 6.3% will be generated through online sales by 2023, which DUNT has access to those markets through their diverse distribution channels.
Investment Thesis: New product offering reaching new markets
New product offerings:
The company’s new products could help augment its revenue by catering to wide range of customers and new health trends due to increasing awareness of the customer base.
In August 2022, the company introduced a new Pumpkin Spice Latte Swirl Doughnut and a new Pumpkin Spice Iced Coffee.
In June 2022, the company launched Mixed Berry Cobbler, Blueberry Cheesecake, Strawberry Shortcake and Mixed Berry Glazed. These donuts would make summer sweeter for its customers. In the same month, the company introduced Original Glazed Soft Serve ice cream. It is available in shakes, cones and cups.
In May 2022, the company introduced Krispy Kreme’s Oh, Honey! collection doughnuts.
In April 2022, the company launched best-ever Original Glazed Cinnamon Roll. In September 2021, the company launched the new Apple Cider Glazed and Maple Glazed doughnuts to its popular seasonal Pumpkin Spice doughnuts
It’s Insomnia cookies and Consumer Product Goods (CPG) line businesses are expected to continue to grow and solidify their position in the markets
For example, Insomnia Cookies are a long-term growth asset as the TAM is huge with market address college students (there being +4000 college campuses in US alone), while having strong economics (27% margin, with <US$200K CAPEX, resulting in less than a year payback period). Since acquiring in 2016, it has grown to account for 18% of U.S and Canada fiscal 2022 Revenue.
Valuation
DUNT, with its current price of USD 14.77 as of 29th June 2023, the DCF valuation indicates a potential 36% to USD20.0 if DUNT can grow their product line with the Food and Beverages market growth of ~ 10% annually (varies depending on the year). Thus, DUNT 3Y DCF Target price will be USD 20.00.
As for assumptions, I assumed an average 10.54% growth annually in line with their products Market Growth (which is slightly pessimistic due to strong competition). I assumed that CAPEX would increase as a steady percentage of revenue as one of the main growth strategies is expansion (both domestically with the Hub and Spoke and Internationally with Franchisee).
Risks and Mitigation
Liquidity Position
Low Liquidity places DUNT at a disadvantage while it seeks to fund any potential opportunities arising in the market.
At the end of FY2021, the current ratio of the company was 0.35, which was due to increase in current liabilities from US$497.8 million in FY2020 to US$526.2 million in FY2021, which increased 30.2%, from an increase in accrued compensation and structured payables.
Its current ratio is below that of its competitors such as Hostess Brands Inc and Starbucks Corp, which reported a current ratio of 1.64 and 0.77, respectively.
However, I believe that while the current ratio is not the best, they business model and structure is applied in such a way that is not too cash intensive and they are approaching the revamped business model and growth strategy in a careful and sustainable way.
Baring a huge economic downturn and sudden change in consumer preferences towards donuts, it should not be too much of a limiting factor.
Exposure to health trends
With a growing emphasis on healthy eating, DUNT’s products, which are high in calories and sugar may not appeal to consumers who are interested in healthy eating. This may hamper the company’s long-term growth.
However, DUNT seems to have already taken note of such trends and in January 2023, launched 2 new doughnuts under 200 calories to cater to the health-conscious consumers. This will likely help cement their market share and appeal to the healthy eating market.
Furthermore, with the strong focus on coffee, DUNT has been making investments in its coffee offerings. They are leveraging on the opportunity to grow its coffee business and compete with other coffeehouse chains given the continued expansion of the global coffee market.
This ensures they are not so reliant on doughnuts which are generally considered ‘unhealthy” and provide them with diverse revenue streams.
Intense Competition
DUNT operates in retail industry which is highly competitive. The competitive factors in the industry include the food quality, concept, convenience, location, customer service and taste.
It becomes important for them to distinguish themselves with its product and offerings in a stiff competitive environment
The company competes with Dunkin’ Donuts, Bimbo Bakeries USA, McKee Foods Corporation and Hostess, among others. If the company is unable to maintain the product quality and consumer loyalty, increasing competition will also force the company to reduce its prices which in turn may adversely affect its margins.
Despite this, Krispy Kreme has been renowned for its unique product offerings, including its seasonal doughnuts and limited-edition collaborations. Maintain relevance and bringing out new, exciting flavours that can help draw new clients. As per the product offerings, Krispy Kreme has been introducing at least 3 new products and partnerships over the past few years. This ensures that DUNT will stay relevant and has a unique edge over competitors.
In the past, Krispy Kreme has partnered and collaborated with businesses like Oreo and Nutella, which have been effective at building buzz and luring new customers. The company has the chance to keep forming these alliances and partnerships to offer its clients fresh flavours and goods.
ESG Analysis
Referencing MSCI, Krispy Kreme compared to its peers has the lowest ESG risk rating and exposure compared to some of its peers. While it’s management role in ESG is only average, it is comparable with its peers in that regard and have made actionable steps to handle their Corporate Social Responsibility.
Social Factor (High): DUNT has a laudable stance as a socially conscious indulgence as the brand cares for the communities where they operate. The company has strong commitments to charitable donations and its social imitative. They have had no prior social issues facing them an engages locally with support and uplift community. An example was when they introduced ‘Beat the Pump” promotion where they aided consumers by pegging the price of a dozen Original Glazed doughnuts to a gallon of gasoline, and they offered free doughnuts to graduating seniors. They have raised more than US$36 million to support local community causes across America.
Regulatory (Poor): Despite being committed to diversity, equity and inclusion, having established a Diversity, Equity and Inclusion Council. DUNT is still regarded as having poor workforce diversity, which can hinder the company’s success in international market given that majority of growth to date had mainly been in the domestic market. This could lead to future financial instability. In the leadership team, female representation is only 2 out of 8 members, which represents a poor ratio. Out of 8 members, only 1 is of minority race. In 2022, the company had to pay $1.2 million to 516 staffers over not issuing wage bonuses. As such, they are focus to strive for gender parity globally and increasing people of representation together with developing comprehensive, global total rewards farmwork to drive pay equity. This should improve such ESG risk in the future.
Environmental (Medium): DUNT has not GHG emissions targets set despite conducing multi-year global emissions assessments to establish their baseline, making them hard to be accountable for their environmental footprint and impact, showing weak environment management. However, DUNT did make progress on responsible sourcing across the global supply chain and has set viable and accountable goals such as using 100% cage-free eggs by 2026 (so far having reached 45% with clear outlines). They are also committed to using sustainable palm oil and achieve 100% deforestation-free palm oil use by 2026 and reduce food waste reduction. These are material and actionable steps that will improve their standing within communities and receive support that has a positive environmental impact.
Conclusion
Since 1937, one of the oldest doughnut and coffee companies are still in high demand due to their ever-increasing range or products and their affordable pricing range, as well as its appealing branding strategies and logo. These are some of the factors that DUNT can provide in terms of customer value in the market.
Despite facing certain challenges operations and financial wise, I believe that this company’s legacy and strong reputation among communities will allow it to take advantage and ride on market growth and opportunities in the food and beverages market for quick service restaurants and expand its product offerings and reach overseas as such providing a 3Y forecast upside return of 36% at US$20.00.
*Do note that all of this is for information only and should not be taken as investment advice. If you should choose to invest in any of the stocks, you do so at your own risk.
Source: CapIQ, Annual Report, Earnings Report, Marketline, GlobalData , Euromonitor, Statista