Summary
- DNUT's 4Q22 earnings were better than expected, and the company's efforts to increase profits in 2H22 paid off.
- The delivered fresh daily segment is expected to be one of DNUT's primary areas of focus.
- I believe margins can certainly improve from here as management rolls out more automation initiatives and also reduces G&A expenses by consolidating offices.
Overview
I believe Krispy Kreme ( DNUT ) is still undervalued by 26%. I continue to expect DNUT to be successful in implementing its business model and also finding success in increasing its market presence in newly identified markets. The thesis on Insomnia Cookies has not changed either, I expect it to be well-positioned to continue expanding its online presence and reach beyond the collegiate market.
4Q22 earnings
Both the top and bottom lines for DNUT's 4Q22 were stronger than anticipated, and the year ended successfully for all three business segments. While DNUT stock has been slow on raising prices, the company's efforts in 2H22 paid off with increased profits in the 4Q. Aside from the United States, other countries, such as the United Kingdom and Mexico, also showed strength.
Not only did 4Q show signs of improvement and positive results, but a number of other key performance indicators also garnered attention. An increase in pricing and DFD expansion, as well as an increase in sales per door, contributed to a 15% year-over-year increase in sales per hub in the United States and Canada. The expansion of hub network plays a significant role in compensating for underperforming areas of the business, as evidenced by the fact that the 15% growth rate is greater than the 12% organic sales growth rate of the entire segment. Apart from that, while it's expected that Sweet Treats will have a lower performance in FY23 compared to previous expectations, the overall growth outlook in the United States is maintained due to the improved performance of the hub network and Insomnia. On pricing in the United States, management has implemented some price increases (low double-digit percentages) to kick off the year. In terms of raw materials like sugar, wheat, and oils, management anticipates high single-digit percentage inflation, while management projects low double-digit percentage inflation for other COGS.
Delivered fresh daily strategy
Growth in the delivered fresh daily ((DFD)) segment should be one of DNUT's primary areas of focus, in my opinion. This is consistent with management commentary suggesting that the DFD channel, specifically sales per door, will be the primary driver of growth for the US business beyond 2023. To put this expansion into perspective, DNUT's management estimates that there could be as many as 15,000 access points in the United States by the year 2026, with 8,000 of those points attainable by the end of the year. This is an increase of 30 percent or more over the current total of doors that DNUT operates. Management has identified around 9,000 doors that could contribute to the growth story if pursued. These doors are divided into three categories:
- About 3,000 doors in new and underserved markets.
- Another 3,000 doors from new customers in existing channels, split between existing and new/underserved markets.
- The final 3,000 doors are expected to come from new customers through new channels in these markets.
The question is, how profitable can this strategy be, or whether DNUT can optimize the driver's route to maximize profit. As such, I am a little worried about the profit per DFD door, but I think DNUT's delivery route optimization has a lot of potential to make this a very profitable segment.
Insomnia
As expected, Insomnia Sweets' growth in its core demographic has been impressive. The company's overall e-commerce sales mix increased to 18.3% in 4Q22 from 15.7% in 4Q21, thanks to a 20% y/y increase in e-commerce revenue for this brand. At the end of FY22, Insomnia had 231 locations, and by the end of FY26, they expect to have 427. This expansion could add $160m in revenue and $32m in EBITDA, representing impressive growth in both metrics.
International
During FY22, international sales will account for 24% of total revenue and 32% of EBITDA, with a margin of 20.6%. While still healthy, this margin is below the 24.5% recorded in FY21 due to more improved than expected UK business prospects. The international model, as we have seen, differs significantly from the American one. Comparing hubs with spokes in the US, the international average is 90 to 45. In order to grow, I believe DNUT must look to markets other than the United Kingdom and Australia. With the continued success of the new DFD door, I expect Mexico to become an important growth area, alongside Canada and Japan. In addition to these, the company's management has found promising prospects in Turkey, Egypt, France, Chile, Brazil, Germany, and Spain.
Margin expansion
To ensure they meet their FY26 margin targets, it is encouraging to see DNUT implementing automation initiatives. DNUT spends over $100 million annually on labor associated with donut production in the United States, the vast majority of which is for post-production tasks (such as boxing and traying) that can be automated. As was discussed during the Investor Day in December 2022, this automation opportunity is possible at the five donut production facilities and 240 hot light theater hubs. Within the next 18 months, management hopes to automate the production of 18% of donuts, saving $2 million annually.
Furthermore, I see opportunity in corporate G&A as the reported G&A of 18% in 4Q22 is significantly higher than other peers. I believe that a good near-term boost to margins can be achieved by consolidating offices as a means of further optimizing G&A.
Valuation
DNUT has performed well against my previous expectations (previous price target was $14.80), especially on the multiples rerating towards mean (15x EBITDA). While the share price has risen, I believe the upside is still attractive after updating for FY25 numbers. Based on the updated model, I expect DNUT to generate $272 million in EBITDA in 2025, and using the same 15x NTM EBITDA, this translates to $16.56/share.
Conclusion
I believe DNUT is still undervalued by 26%. The DFD strategy has further potential for growth, and management has identified a 15,000 access point opportunity in the US by 2026. Insomnia Cookies is also still well-positioned to expand its online presence and reach beyond the collegiate market. Overall, I am still positive on DNUT's growth and margin expansion outlook, hence, I reiterate my buy rating on the stock.
For further details see:
Krispy Kreme: Expect Margins To Continue Improving From Here