The key to Krispy Kreme's success has been the freshness of the doughnuts. Way back in 1937, patrons lined up at Krispy Kreme's plant in order to buy the treats while they were still hot. But with expansion necessary to realize Krispy Kreme's business model, freshness is the first thing that will be sacrificed at the altar of growth. Krispy Kreme efforts to "maximize store productivity by selling off-premises to grocery and convenience stores" will undermine its ability to continuously deliver the freshest and hottest doughnuts around.
Don't believe me? While doing my Foolish research, I visited a New York City Krispy Kreme shop. I figured if you can make it there, you'll make it anywhere. Under the spell of addicted Krispy Kreme lovers who sugarcoat the Internet's walls with their confessions, this Krispy Kreme virgin dreamed about the hot, sweet confection deliciously melting in my mouth.
Much to a bull's chagrin, the store was empty at 8:45 on a Monday morning. And dirty. Worst of all, the doughnuts were not warm and didn't taste any better than the grocery variety. Since Krispy Kreme's franchisees are independent contractors, not employees, Krispy Kreme will have problems keeping the "quality" in quality control, and systemwide sales could decline as a result.
As I ate my doughnut, two middle aged men with gigantic bowling balls in their bellies devoured their confections. These guys were poster boys for the health risks of Krispy Kreme! No svelte, beautiful New Yorkers crossed the threshold. Which led me to wonder -- with the trend towards healthier eating in America, how are doughnuts, a fried concoction consisting of sugar and lard, going to take over? We have seen the future, and he is not Homer Simpson.
Krispy Kreme adds to their doughnuts' mystique by describing the way they're made: "Float your raised-up doughnuts across the real warm vegetable shortening, flip them over, bring them out and send them under a refreshing waterfall of glaze that your other helper has made from sugar sweeter than a mother's kiss." (My mother's kiss not withstanding, these copywriters must have found inspiration while on a sugar high.)
That "real warm vegetable" shortening is gonna raise blood cholesterol levels, increasing the risk of developing arteriosclerosis, heart disease, obesity and arthritis, a group of not-so-yummy diseases. Put that in your oven and bake it.
Recently, the American Institute for Cancer Research and the World Cancer Research Fund discovered that dietary changes could prevent nearly 40 percent of the world's cancers. As Americans become enlightened to these health risks, doughnuts will appeal to a much smaller market -- namely those whose self-destructive urges compel them towards danger. Is it any wonder that these sweet lardy delights are the favorites of policemen? If you face a strong daily risk of being killed by a bullet, slow death by doughnuts seems mild by comparison.
As for sugar being "sweeter than a mother's kiss" -- that's great if your mother is Medea. According to the best-selling book Sugar Busters, "refined sugar in any significant quantity is toxic to many human bodies, and it certainly helps make many bodies fat," and "may be the number one culprit in lowering quality of life and causing premature death." Biting into the creme-de-la-KREM is biting into a chunk of rotten teeth, heart disease, and diabetes. Yum yum.
Since there are no new product lines, Krispy Kreme's growth is dependent upon its ability to open and successfully manage new stores. Krispy Kreme contracts with developers for specific geographic territories, and depends upon them to discover adequate locations and financial support. If developers don't deliver on schedule, Krispy Kreme's intended growth will slow and shareholders will suffer a hardening of the profits.
Even if developers find appropriate sites, there's no guarantee franchisees will open new stores on schedule, once again impeding the company's growth. No stores, no sales. No sales, no wildly over-valued stock price.
Overvalued? I'll say! Krispy Kreme has the highest P/E ratio of all comparable companies in its peer group, as well as lower than average gross margins. In order to deserve that P/E, a lot of sugar and lard-laden doughnuts must be devoured by more consciously healthy Americans. Even though same-store sales have increased 19% this year, it's unlikely Krispy Kreme can sustain such a growth rate. Its stock is overvalued, and its customers are overweight.
As Tom Gardner recently wrote: "The public marketplace is set up to reward the shareholders of companies pursuing limitlessly sustainable growth. To win as investors, we have to instead find companies with ambitious dreams and practical expansion plans for the next five years, the fifty after that, and then forever into eternity."
While Krispy Kreme has ambitious and practical expansion plans over the next five years, where can it go over the next fifty? A doughnut store on every block? Sure, right next to a hospital, since eating doughnuts will speed up the journey to get there.
It's time to sell the doughnuts.
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