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Krispy Kreme Surging 26% as Hot Sales Spur Takeover Talk: Retail

Jan. 14 (Bloomberg) -- Krispy Kreme fans know a batch of glazed doughnuts is fresh off the production line when their local store turns on the neon “Hot Now” sign. It’s an apt metaphor for a brand that seemed to have gone stale.

After falling victim to headlong expansion and America’s obsession with low-carb diets, Krispy Kreme Doughnuts Inc. has revived itself by moving beyond its sugary signature product and adding fruit juice, oatmeal, smoothies and coffee to the menu. Quarterly sales have risen for more than two years, and fiscal 2013 sales are forecast to match pre-recession levels.

The shares have soared 26 percent this year amid speculation that the 76-year-old chain is a takeover target. Krispy Kreme advanced 4 percent to $11.82 at the close in New York, the highest price since 2007.

Americans grazing between meals are looking for “smaller, more frequent purchases” rather than spending $15 to $30 at a casual-dining chain such as Applebee’s, said John Gordon, the principal at Pacific Management Consulting Group, a restaurant adviser based in San Diego.

Coffee and snack shop sales are forecast to increase 4 percent annually to reach $33.9 billion in 2017, compared with growth of 1.9 percent a year for fast-food chains during the same period, according to reports from Santa Monica, California- based researcher IBISWorld Inc.

Krispy Kreme’s 2.1 percent U.S. market share remains tiny compared with Starbucks Corp.’s 36 percent and Dunkin’ Brands Group Inc.’s 25 percent, according to IBISWorld. Still, the doughnut chain is poised to become a growth company again, according to Nick Setyan, a Los Angeles-based analyst at Wedbush Securities.

Growth Company

Thanks to improved profitability, the Winston-Salem, North Carolina-based company can “start growing and adding stores,” he said in an interview.

Krispy Kreme is becoming more valuable to investors relative to other eateries. On Jan. 11, it traded at a 75 percent price-to-earnings ratio discount to the Standard & Poor’s 500 Restaurants Index, compared with an 87 percent discount in May, according to data compiled by Bloomberg.

The chain may lure bids from other eateries looking to boost morning food and drinks sales with its cult-like following. Wendy’s Co. may look at Krispy Kreme as a way to boost its breakfast sales, said Conrad Lyon, an analyst at Los Angeles-based B. Riley & Co. Setyan says the company is also a potential buyout candidate for a private-equity firm at as much as $13 a share, 14 percent more than the Jan. 11 closing price.

Chef’s Recipe

In 1937, Vernon Rudolph, a Kentucky-born entrepreneur, opened a factory in Winston-Salem and began cranking out yeast- raised doughnuts based on a recipe acquired from a New Orleans chef. He cut a hole in the factory wall and began selling them to passers-by. By the late ’90s, the Krispy Kreme glazed doughnut had become a cultural icon and even starred in a 2002 episode of “Sex and the City.” Today, there are 240 stores in the U.S. and an additional 490 overseas.

The doughnut seller’s pell-mell expansion caught up with it, though, and by 2005 the company’s board had ousted its CEO and several executives amid an accounting scandal. The stock plummeted, the company was forced to close half its stores and 14 quarters of losses ensued. In early 2008, James Morgan, a former securities executive, became chief executive officer.

At the time “there was such a cloud over the company,” said Peter Tourtellot, a founding principal at Anderson Bauman Tourtellot Vos, a turnaround adviser based in Greensboro, North Carolina. “They’ve done a very, very good job in turning that company around against very adverse conditions.”

U.S. Growth

“There’s still a lot of growth left in the U.S.” for the doughnut seller, Tourtellot said. “All you’ve got to do is look at Dunkin’ Donuts -- Krispy Kreme can do just as well.”

Morgan has begun pushing the brand beyond its stronghold in the U.S. Southeast. Last year, Krispy Kreme celebrated its 75th anniversary with a bus tour dubbed “Glaze the Nation.” The so- called Krispy Kreme Cruiser, a restored 1960 Flxible Starliner, doled out doughnuts, t-shirts and other swag across U.S. states and will continue its circuit this year.

Krispy Kreme also added a digital flourish to its retro “Hot Now” signs: a “Hot Light” app for smartphones that alerts customers when the sign is lit at the closest local store. The app has been downloaded 250,000 times since its debut in December 2011, according to the company.

The marketing efforts are working. In November, sales rose 8.5 percent in the three months ended Oct. 28 amid stronger customer traffic and gains selling doughnut mixes and other ingredients to franchisees.

Growing Room

Sales may rise 8.5 percent to $437.5 million in the fiscal year ending this month, which would be the highest since fiscal 2007, according to data compiled by Bloomberg. That’s also larger than the revenue increases forecast for Dunkin’ Brands and McDonald’s Corp. in 2012, the data show.

“In the United States, we clearly have lots of room to grow,” Morgan said on a conference call Nov. 19.

Krispy Kreme plans to open as many as 10 company and 15 franchised U.S. locations, along with 75 international shops, this year. The chain has been expanding west and and north and has recently opened stores in Arizona and New Jersey.

Selling more drinks would help Krispy Kreme expand margin, said Conrad Lyon, an analyst at B. Riley & Co. in Los Angeles. Gross margin for drinks is as much as 85 percent, compared with about 70 percent for food, Lyon said. While beverages make up approximately 12 percent of sales, Krispy Kreme has said it can increase that to at least 20 percent if it sells more coffee.

And for those worried about packing on the pounds from too many doughnuts, there’s a Krispy Kreme Challenge, where participants run five miles, gobbling doughnuts mid-race. The original event in Raleigh, North Carolina, which began in 2004, has gained such a following that Krispy Kreme races have proliferated across the nation.

Don’t worry, say the race websites: scarfing down the doughnuts is completely optional.

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