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August 27, 2004 |
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Krispy Kreme reported weaker than expected financial results yesterday and its stock price was creamed for a 10+% loss. Further stock price erosion in the coming months could open up a sweet opportunity for the value minded investor. However, even after the sell off KKD remains an expensive stock still owned by investors seeking corporate procured EPS growth.
There is probably a logical explanation for the differences (in red). It is a shame KKD did not provide it. Other restatements in recent years are too numerous to list. However, from year to year it is as if the company does not know how much money it has in the bank (Feb 1, 04 balance sheet originally had $21.09 million in cash but this figure was revised to $20.3 million in the company’s last 10Q). Annoyance # 2: Hand Selecting Statistics When KKD released its quarterly update yesterday the company included a balance sheet snapshot. In this snapshot the second largest asset group, next to property, was “other assets”. The company has a breakdown to these numbers readily available but failed to provide it. Thus, the investor is not shown the company’s massive intangibles. In fact, the word ‘intangibles’ – like the phrase ‘stock options’ - is not mentioned at all. Am I nitpicking? Perhaps. But perhaps also the company has a history of overstating intangibles? Consider these contrasting statements made by KKD: “During the three months ended May 4, 2003, the carrying amount of goodwill increased $29,915,000 as a result of the acquisition of Montana Mills Bread Co., Inc. ("Montana Mills") and the carrying amount of reacquired franchise rights increased $28,844,000 primarily as a result of the acquisition of the rights to certain markets…The Company has determined that all intangible assets have indefinite lives and, as a result, are not subject to amortization…” May 4, 2003 ~ 10Q SEC Filings “In the first quarter of fiscal 2005, the Company adopted a plan, approved by the Board of Directors, to divest the existing Montana Mills Bread Co., Inc. ("Montana Mills") operations. The impairment charge consists of the write-off of goodwill recorded in connection with the acquisition of $19,664,000, the write-off of amounts recorded as the value of trademarks and trade names and recipes acquired of $12,081,000 and provisions, totaling $2,786,000…” May 2, 2004 – 10Q My point in highlighting these quotes is to show how the company withheld (in my opinion) impairment charges on Montana. In other words, how the company misrepresented what its assets were actually worth. Think about it this way: there were no impairment charges in fiscal 2004, yet in the first quarter of 2005 Montana suddenly becomes a complete write-off? Common sense says that Montana’s operations didn’t crash overnight. Question: would so many insider sales have been completed at such lofty prices (2003) if the true financial state of Montana had been quickly disseminated? We will never know (these are my opinions only – not many analysts worry about intangibles from quarter to quarter). Incidentally, Montana Mills represents an extremely unsuccessful acquisition: in little over 1-year the company went from purchase the company to trying to get rid of it (still trying...). Other annoyances/issues - From fiscal 2002 to fiscal 2004 the company consistently downgraded estimated stock volatility (from 52.5% in 2002 to 41.6% in 2004). Whether done for unscrupulous reasons or not, declining volatility expectations have lessened the fair value of the company’s stock options. - The company doesn’t expense stock options. - The SEC is investigating KKD’s accounting practices (relating to store repurchases). - Kroger is, in select locations, beginning to bake their own donuts. - Atkins. But The Company Does Make A Popular Donut! Annoyances and issues aside, the history and popularity of Krispy Kreme suggests that the company will survive. And while the recent decline in revenues and margins is ominous, it is not uncommon for high growth companies to hit a wall after many years of super growth. That KKD hit its wall after 5-years in a row of rising margins could simply mean that the company needs to retool; focus on cash flows and debt reduction while reducing the amount of new ventures being undertaken.
Speculations About Price Krispy Kreme has $4.15/share in tangible equity. This figure is only worth considering if KKD is no longer going to be a viable interest (i.e. if non performing stores are being sold for their assets and the intangibles are worth nil). KKD shares would have to fall another 70% to reach $4.15. Given that it is not likely that a company like Krispy Kreme is going to trade at tangible book, other figures are worth considering: namely price to sales. Using the last four quarters in revenues, KKD would need to trade at $11.32/share to be trading at a price/sales of 1. Suffice to say, I noted ‘value minded’ instead of ‘growth minded’ earlier because KKD may be worth purchasing when, and if, its price/sales ratio dips below 1. An p/s investment of this sort – using an expected ROA type approach (2.2% per quarter since Jan 01) - is a value rather than a growth investment approach. Using the last four quarters, the company is currently (even after shares have been slammed) trading at 35 times free cash flow. Paying 35 times free cash flow for a dividendless company is, in my opinion, insane. Since he likes to deal with quality managers I have my doubts about Warren Buffett ever taking a stake in KKD. Nevertheless, other would be Buffetts’ will arrive when, and if, the company/s p/s ratio nears 1. Of course, this is assuming that the decline in revenues is over. BWillett@fallstreet.com |
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