At the end of May, Krispy Kreme Doughnuts (NYSE:KKD) shot up over 23% in share price on a boosted earnings forecast and very positive first quarter results. Krispy Kreme now expects higher EPS numbers for the year, coming in between $0.59-$0.63 after net income rose 33% to $8 million, versus $6 million a year prior. This marks the 18th straight quarter the doughnut chain has increased same store sales and this trend has helped increase the share price nearly 80% for 2013 alone.
Krispy Kreme Doughnuts (NYSE:KKD) is clearly on the right track after spending most of the past decade trying to fix the mistakes of rapid expansion throughout the United States and around the globe, several IPO and accounting scandals and management musical chairs. Currently, Krispy Kreme has 748 total locations, and profit margins are improving. The average quarterly profit margin for the last five years has been 2.28%; however, the last three quarters have been 4.71%, 4.05%, and most recently, 4.77%. In order for Krispy Kreme Doughnuts (NYSE:KKD) to truly reach its potential, though, it needs coffee.
Too old fashioned?
Krispy Kreme Doughnuts (NYSE:KKD)’s biggest problem is not its signature Original Glazed doughnut, but its coffee–or lack thereof. Only 5% of overall store revenue is coffee, despite its much higher margins than doughnuts. Its doughnuts comprise approximately 88% of retail sales with the rest of the balance belonging to a complimentary products category, which coffee falls under next to the milks, juices and frozen drinks.
CEO Jim Morgan stated in May that he doesn’t want to be compared to Dunkin Brands Group Inc (NASDAQ:DNKN), since over 65% of that business is coffee sales. However, Morgan says he’d like to see the ratio of Krispy Kreme Doughnuts (NYSE:KKD) sales closer to 80% doughnuts and 20% coffee in the near future. His expectations are somewhat contradictory to his other notion that he doesn’t want to fix the company by changing the menu. That is sort of like trying to eat healthier without changing your diet at all–it really doesn’t make sense.
Head-to-head, Dunkin Brands Group Inc (NASDAQ:DNKN) is everything Krispy Kreme should strive to be. Most Krispy Kreme locations carry about 16 doughnut varieties, while the traditional Dunkin location carries over 70. In addition, Dunkin has a complete breakfast sandwich lineup, as well as a variety of bakery sandwiches. Dunkin’s 9.28% average quarterly profit margin the past five years continues to soar, as in its most recent quarter it was 15.96%. It goes to show that coffee plays a big role in the gap in margins between the two chains. Overall, Dunkin’s diverse menu gives the typical customer a lot more reasons to visit than the Krispy Kreme menu does.
Coffee just makes sense
Between 6am and 11am, Krispy Kreme experiences 36% of sales. Therefore, it would only make sense to promote coffee consumption during this time. Coffee is one of most consumed beverages in the world, and 54% of Americans over 18 drink coffee every day. That comes out to over 100 million U.S. daily coffee drinkers each paying an average price of $1.38 per cup of coffee that costs just pennies to sell. The high margins and the $18 billion market in the US alone, which is growing annually, is the perfect reason why Krispy Kreme should set higher goals for coffee.
The Domino effect
Many attribute the Domino’s Pizza, Inc. (NYSE:DPZ) comeback story to its 2010 apology campaign, where it finally admitted that it had lousy pizza. However, the business has also evolved tremendously the last 25 years from a two size, 11 topping pizza delivery service to a global brand that serves not just pizza, but boneless chicken, chicken wings, pastas, sandwiches, breads, chips, and deserts.
Less than five years ago, Domino’s Pizza, Inc. (NYSE:DPZ)’s was mainly an 80%-90% delivery business, but today over 30% of sales are pickup. As far as desserts go, its Lava Crunch Cake, introduced in 2009, gives people another reason to visit the chain. The goal should be to get people in the doors, and add-ons like dessert can only improve margins and help the bottom line. Global revenue and domestic sales increased 8.6% and 7.8%, respectively, for the first quarter of 2013. Net income soared up nearly 66% due to same store sales growth, international store count, and improved margins.
Wake up
Krispy Kreme is at its highest share price in eight years. However, it still has over halfway to go to reach its peak share price of a decade ago. Its 700+ locations, stubborn menu, and business philosophy doesn’t look like it can support its growth rate and the high expectations the P/E of 60 demands. Perhaps it is time for it to evolve. The population has a healthier mindset and doughnuts might not be so attractive now. Expand the menu and give people another reason to visit a store besides to pick up a dozen doughnuts while holding a rival company’s meal or beverage. Wake up and smell the coffee Krispy Kreme — maybe even taste it too.
Michael Carter has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned.
The article Krispy Kreme Needs to Wake Up and Smell the Coffee originally appeared on Fool.com and is written by Michael Carter.
Michael is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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