Krispy Kreme’s stock price has taken a beating over the past six months, shedding 57.7% of its value and falling to $4.53 per share. This was partly due to its softer quarterly results and might have investors contemplating their next move.
Is there a buying opportunity in Krispy Kreme, or does it present a risk to your portfolio? Get the full stock story straight from our expert analysts, it’s free.
Even with the cheaper entry price, we're cautious about Krispy Kreme. Here are three reasons why we avoid DNUT and a stock we'd rather own.
Why Is Krispy Kreme Not Exciting?
Famous for its Original Glazed doughnuts and parent company of Insomnia Cookies, Krispy Kreme (NASDAQ:DNUT) is one of the most beloved and well-known fast-food chains in the world.
1. 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 4.5%, meaning it lit $4.50 of cash on fire for every $100 in revenue.
2. Previous Growth Initiatives Haven’t Paid Off Yet
Growth gives us insight into a company’s long-term potential, but how capital-efficient was that growth? A company’s ROIC explains this by showing how much operating profit it makes compared to the money it has raised (debt and equity).
Krispy Kreme historically did a mediocre job investing in profitable growth initiatives. Its five-year average ROIC was 0.1%, lower than the typical cost of capital (how much it costs to raise money) for restaurant companies.
3. Short Cash Runway Exposes Shareholders to Potential Dilution
As long-term investors, the risk we care about most is the permanent loss of capital, which can happen when a company goes bankrupt or raises money from a disadvantaged position. This is separate from short-term stock price volatility, something we are much less bothered by.
Krispy Kreme burned through $74.96 million of cash over the last year, and its $1.35 billion of debt exceeds the $29.32 million of cash on its balance sheet. This is a deal breaker for us because indebted loss-making companies spell trouble.
Unless the Krispy Kreme’s fundamentals change quickly, it might find itself in a position where it must raise capital from investors to continue operating. Whether that would be favorable is unclear because dilution is a headwind for shareholder returns.
We remain cautious of Krispy Kreme until it generates consistent free cash flow or any of its announced financing plans materialize on its balance sheet.
Final Judgment
Krispy Kreme isn’t a terrible business, but it isn’t one of our picks. Following the recent decline, the stock trades at 14.5× forward price-to-earnings (or $4.53 per share). While this valuation is reasonable, we don’t really see a big opportunity at the moment. We're fairly confident there are better stocks to buy right now. We’d suggest looking at a top digital advertising platform riding the creator economy.
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