The Hole in the Middle of Krispy Kreme
On July 1, doughnut chain Krispy Kreme (NSDQ: DNUT) returned to the public markets after an initial public offering (IPO) at $17. The company went private in 2016 after its previous IPO in 2000.
Five years ago, private equity firm JAB Holding bought Krispy Kreme for $1.25 billion. Last week’s deal values the company at a little over twice that amount. And that is after the IPO price was reduced by 20% as a result of lackluster demand from institutional investors.
With the stock market at record highs and demand for snack foods on the rise, the middling interest in DNUT is concerning. Its biggest direct competitor, Dunkin’ Donuts, is now privately held after being acquired by Inspire Brands last December.
That makes DNUT the only pure play on retail doughnut chains operating in the United States. There are 363 Krispy Kreme stores in the U.S. plus another 1,000 locations in 33 countries. The company also sells its doughnuts through 12,000 retail merchants.
Last year, Krispy Kreme racked up $1.1 billion in sales. More than 60% of that amount was for its Original Glazed doughnut. To its loyal adherents, there is nothing better than a Krispy Kreme glazed doughnut with their morning cup of coffee.
Nevertheless, the money managers on Wall Street are wary of Krispy Kreme. The company has a troubled past riddled with accounting errors and financial restatements that ultimately led to bankruptcy in 2009.
Of course, that management team is long gone so it isn’t fair to conflate those problems with the company’s current leadership. This team is on the ball. Earlier this year, the company offered a free doughnut to anyone that presented a COVID-19 Vaccination Record Card at one of its stores.
Since Dunkin Donuts is private, some analysts are using Starbucks (NSDQ: SBUX) as a comparison for Krispy Kreme. However, the two companies are quite different in both size and scope.
At a market cap of $135 billion, Starbucks’ stock market value is roughly fifty times that of Krispy Kreme. Also, food sales comprised less than 20% of Starbucks’ total revenue last year.
The problem Wall Street is having with Krispy Kreme is that it is essentially a one-product company. And unfortunately, the one product may soon find itself in the crosshairs of the environmental, social, and governance (ESG) movement.
It is no secret that doughnuts are among the unhealthiest foods known to man. The Cleveland Clinic ranks doughnuts and pastries as the #1 “Worst Breakfast Foods for You.”
As their survey notes, doughnuts contain “a huge amount of sugar” which means “your body pumps out loads of insulin to try to accommodate.” The result is a “vicious cycle of unhealthy eating” that leads to “obesity, heart disease, and diabetes.”
Of course, there is no law against eating doughnuts. Or pizza, cheeseburgers, and a host of other foods that also contribute to those same medical conditions.
For that matter, it is perfectly legal for adults to consume tobacco even though its association with heart disease and cancer are well established.
Cigarette manufacturer Altria Group (NYSE: MO) is appeasing the ESG community by pronouncing its commitment to converting smokers to non-combustible forms of tobacco consumption. That tack seems to be working even though last year less than 0% of its net revenue came from those products due to huge write-downs taken against that investment in 2020.
According to the Food Institute, “active ESG management is directly linked to superior financial performance.” The higher a company’s ESG score, the easier it will be to attract ESG-based capital.
At the moment, attracting capital is not a problem for Krispy Kreme. Most of its stores are franchised, funded by the franchisees.
What could become a problem for Krispy Kreme is growing pressure to be less reliant on glazed doughnut sales for most of its revenue. At the moment, ESG Metrics do not measure the associated medical costs of individual food products.
I believe that day is coming. Health care costs are skyrocketing, especially among retirees on Medicare and Medicaid. The research firm Statista estimates, “Almost 29 percent of those aged 65 and older in the U.S. were obese in 2020.”
Thus far, the Food & Drug Administration (FDA) has been reluctant to crack down on the food choices we make. Attempts to curb consumer choices are immediately shouted down with charges of “nanny state” interference.
But sooner or later, the escalating costs of treating obesity-related diseases will demand some sort of intervention. And when that happens, doughnuts could very well be at the top of that list.
Fact is, in addition to Krispy Kreme, I know of several other high-flying stocks that are due to take a big fall soon. The red-hot NASDAQ currently hovers at a record high. However, there’s a slew of much-hyped “story stocks” in the tech sector that trade at nosebleed levels and they’re poised for a tumble.
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