Do Delicious Doughnuts Make Your Portfolio Fatter?

Krispy Kreme Doughnuts KKD shares are a little doughier this morning, after the doughnut maker reported much better than expected earnings. The Winston-Salem, NC-based company reported second quarter earnings of 12 cents on $98 million in revenues. Wall Street had been expecting earnings of 6 cents per share on $92.26 million in revenues. James H. Morgan, President and Chief Executive Officer, commented: "Our second quarter performance was the best of any second quarter since fiscal 2005 and reflects the progress we've made in executing our strategic plans. We generated double-digit revenue growth in each of our business segments, doubled earnings per share excluding a nonrecurring gain of $0.06, and expanded the Krispy Kreme system with a net 17 new stores. Moreover, our results were generated in the face of higher agricultural commodity prices, extreme temperatures, and much higher gas prices compared to the year ago period. Based upon our year-to-date financial performance, we are very pleased to be reiterating our annual outlook for fiscal 2012 consolidated operating income, exclusive of impairment charges and lease termination costs, of between $22 million and $24 million. We continue to believe the high end of this range is achievable and look forward to building on our recent momentum as we move toward calendar 2012." The company now has 669 locations, mostly owned by franchisees. It added 17 locations this quarter, and recently announced plans to expand in Japan. It will build 73 new locations in the Kanto, Kansai and Chubu regions of Japan over the next five years. "We are delighted to extend our relationship with Krispy Kreme Doughnut Japan Co., Ltd., which has been our franchise partner since 2006," said Jeff Welch, Krispy Kreme President, International. "They are an outstanding operator, and we look forward to a continued association with them as they share the one-of-a-kind Krispy Kreme experience with consumers in Japan." The company improved all of its metrics during the quarter, with gross margins rising, and cutting costs as well. General and administrative expenses fell to $4.9 million in the quarter, and operating income increased to $4.9 million from $4.2 million. These are both healthy signs, and are reflected in the bottom line beat. Cash is up in the quarter, ($32 million), and Krispy Kreme actually now has more cash than long term debt ($26 million). On the product front, Krispy Kreme is expanding its menu, offering more drinks and will begin testing new food items soon. Drinks tend to have higher margins than food, which should benefit Krispy Kreme's gross margin percentage in a positive manner going forward. Beverages account for roughly 12% of store sales, and as this percentage rises, so should the gross margins. The company also added that it has raised prices on roughly 60% of its items, which should help margins as well. Shares trade at 21.5 times forward earnings, but the company has been able to generate strong revenue growth year-over-year, and the company is being rewarded with a rich multiple. Despite today's 12% rise in shares, Krispy Kreme may prove to be a sweeter investment than most, especially as the company continues to expand around the world. ACTION ITEMS:

Bullish:
Traders who believe that Krispy Kreme will continue to improve operations might want to consider the following trades:

• Despite the high valuations, Krispy Kreme is still in the midst of a turnaround. Traders who believe in the story may want to add on dips.

Bearish:
Traders who believe that Krispy Kreme will get hit by a global recession may consider alternate positions:

• As the economy slows, consumers tend to trade down or cut down on discretionary purchases. Doughnuts are not exactly staple purchases, and Krispy Kreme could see a slowdown in sales as the global economy turns for the worse.
  
  

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