Krispy Kreme has followed the market’s trajectory closely, rising in tandem with the S&P 500 over the past six months. The stock has climbed by 11.9% to $3.30 per share while the index has gained 13%.
Is now the time to buy Krispy Kreme, or should you be careful about including it in your portfolio? Get the full breakdown from our expert analysts, it’s free.
Why Do We Think Krispy Kreme Will Underperform?
We’re sitting this one out for now. Here are three reasons why there are better opportunities than DNUT, plus one stock we’d rather own.
1. Long-Term Revenue Growth Disappoints
A company’s long-term sales performance is one signal of its overall quality. Any business can put up a good quarter or two, but the best consistently grow over the long haul. Over the last seven years, Krispy Kreme grew its sales at a mediocre 6.2% compounded annual growth rate. This was below our standard for the restaurant sector.
2. Cash Burn Ignites Concerns
Free cash flow isn’t a prominently featured metric in company financials and earnings releases, but we think it’s telling because it accounts for all operating and capital expenses, making it tough to manipulate. Cash is king.
Over the last two years, Krispy Kreme’s capital-intensive business model and large investments in new physical locations have drained its resources, putting it in a pinch and limiting its ability to return capital to investors. Its free cash flow margin averaged negative 3.3%, meaning it lit $3.32 of cash on fire for every $100 in revenue.
3. High Debt Levels Increase Risk
Debt is a tool that can boost company returns but presents risks if used irresponsibly. As long-term investors, we aim to avoid companies taking excessive advantage of this instrument because it could lead to insolvency.
Krispy Kreme’s $1.26 billion of debt exceeds the $22.14 million of cash on its balance sheet. Furthermore, its 8× net-debt-to-EBITDA ratio (based on its EBITDA of $158.1 million over the last 12 months) shows the company is overleveraged.
At this level of debt, incremental borrowing becomes increasingly expensive and credit agencies could downgrade the company’s rating if profitability falls. Krispy Kreme could also be backed into a corner if the market turns unexpectedly – a situation we seek to avoid as investors in high-quality companies.
We hope Krispy Kreme can improve its balance sheet and remain cautious until it increases its profitability or pays down its debt.
Final Judgment
We see the value of companies helping consumers, but in the case of Krispy Kreme, we’re out. That said, the stock currently trades at 44.2× forward P/E (or $3.30 per share). This valuation tells us it’s a bit of a market darling with a lot of good news priced in - we think there are better stocks to buy right now. Let us point you toward the most dominant software business in the world.
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