Krispy Case Analysis.docx

Case Analysis: Krispy Kreme Doughnuts

1. Analysts are predicting that Krispy Kreme will be able to perform highly effectively and continue to grow rapidly in the coming two years. What are the keys factors underlying the growth (at least 2)? Do you agree with their analysis? What are some potential concerns (at least 2)? Ans: Analysts are predicting that Krispy Kreme will be able to perform highly effectively and continue to grow rapidly in the upcoming two years. Several factors can be the result of this rapid growth. Krispy Kreme’s brand is based on high quality products. They continue to excel in their field of providing top quality doughnuts to satisfy the needs of the consumer. Furthermore the fact that competition is fragmented with less brand recognition, this places Krispy Kreme up there, making it a leader in it’s industry. Krispy Kreme also carries strong and sold opportunities to expand their network of stores geographically. Having shops located in different regions and areas, makes the shop easily accessible to its consumers. The more Krispy Kreme stores found out there, the higher the profit margin is for the corporation with increased sales and thus greater revenue being generated. Just like Starbucks for example, one can clearly see how they’ve successfully expanded geographically with shops found on the corner of every street. This increases the accessibility to consumers, as well as the company’s overall corporate image. When walking down the street and seeing multiple Krispy Kreme signs, one will eventually want to enter the store and purchase something just for the sake of satisfying their own intrinsic needs. The fact that it’s a small store with new innovative technology, gives the company the competitive advantage it needs on top of other stores in order to beat their competitors. Each and every single corporation out there has potential risks and concerns that they would need to consider and find possible solutions to mitigate such risks. In the case of Krispy Kreme particularly, one should acknowledge the fact that consumers may get bored of donuts and stop buying them. Donuts have been around for centuries and have been popular for many years amongst consumers. However, no one really knows if consumers will continue to purchase donuts in the upcoming years or not. In order to avoid this from happening, Krispy Kreme needs to start and diversify their products and provide consumers with products other than donuts, such as sandwiches, cocktails and such. Competition is another factor that has to be taken into consideration. No one really knows if another company opens up that would also sell donuts and may take over the market share that Krispy Kreme currently maintains. This is likely to be a long-term risk that has to be taken into account; and in order to fight it Krispy Kreme needs to distinguish itself amongst other competitors by holding a competitive advantage over them in order to keep getting consumers to come back.

2. What factors did the CIBC analysts examine to forecast sales growth for KKD in the years ended January 2003 and 2004? What assumptions did they implicitly make about the number of new stores and weekly sales per store (for both company and franchise stores)? What are their implicit assumptions about revenue growth from franchise operations and KKM&D? Do you agree with these forecasts? Explain. Ans: The CIBC analyst’s forecasts were primarily constructed using per store information. - Krispy Kreme plans to expand and add 62 new stores in the year 2003, mostly through area developers. - Baring in mind that the revenues per new store may vary from store to store. Essentially it begins with an initial boom followed by a constant state of where they level off. - Not all of their new stores are fully open and operational throughout the whole year - Company store growth is found to be stable dropping significantly from 28% to 4% just in their last year. Franchise store revenue growth is yet to be regarded as high, as the number of area developers increase, with store revenue patterns comparable to company stores. This is inclined to continue and go on for several years up to until revenues per store are similar for the company and franchise stores. - Royalty revenues have been increasing significantly since area developers pay higher royalty rates as opposed to old associates (5.5% vs. 3%). Hence they averaged a sum of 4% for the last 2 years. - KKM&D revenues are found to be derived by franchise revenues, seeing that sales are to franchisees and thus would vary based on their volume. They have found to have averaged 33% of franchise sales found in the last two years.

3. What assumptions were made about specific expense items? (eg margins, G&A, D&A and taxes? Do you agree with these forecasts? Explain. Ans: Forecast Gross Profits per store: Such figures vary from company to company; however, in the case of Krispy Kreme the company has show an increase of 18% for company stores. Royalty income has a 65% margin, and KKM&D is 17%. CIBC analysts have forecasted that margins increase to 19% for company stores, 70% for franchise operations, and an approximate of 18.5% for KKM&D. The following figures are used to get the following costs.

- Forecast other costs: Depreciation and G&A costs have averaged 9% of sales for the last three years. CIBC analysts show this 9% declining marginally in ’04 to 8.74%. Furthermore, minority interest, specifically franchises has been around 0.3% of the franchise revenues for the last two years. - Forecast interest expense: this requires assumptions to be made about the firm’s overall capital structure. The beginning capital structure is provided and given to us, which shows that Krispy Kreme has a negative net debt of $20 million. This arises from the prior year’s decision to raise new equity to meet future growth plans that the company might take. This implies that it will probably draw down cash for the net year. It seems reasonable to assume that the company expects to draw down its cash (37$ million in Feb. ’02) almost completely to finance its growth. This would imply that net debt would be close to zero in one year’s time, leaving no interest on income or expense. - Forecast tax rate: it is found to be around 38%

4. In general, do you expect analysts’ forecasts for a company like KKD to be optimistic, pessimistic or unbiased? Why? Ans: Personally, I would expect the analyst’s forecasts for a company like Krispy Kreme to be fairly optimistic, and the reason for that is as follows. Analysts in general receive bonuses if they play a significant role in attracting a company as an investment-banking client, or if they play a role in selling issues towards the investors. Because of this, it is unlikely that analysts will be very critical of a company seeing that they would want to encourage it’s management to use the firm for new equity placements. Furthermore, analysts at most banks are rewarded based on commissions generated for the companies they follow. This provides them with the incentive to push and work harder in conducting a much more efficient research base that would encourage investors to trade. Due to the costs of short selling and identifying investors that already own stocks, it makes it easier for analysts to increase their trading volume by producing a strong research background that would encourage investors to purchase stocks. Institutional investors also reward analysts on a commission basis; however, they are found to be much more explicit in terms of providing feedback on which reports are found to be valuable and which aren’t. They also carry the advantage of having access to research reports conducted by other analysts, this makes it easier to rate an analysts research compared to the research conducted by other analysts that are reporting on the same company.