2023-04-17 15:48:44 ET
Summary
- Revenue should benefit from price increases and global POA expansion.
- Price increases should also offset inflationary headwinds in the near term.
- In the longer term, margin should benefit from improving the business mix and cost savings.
- Valuation is expensive.
Investment Thesis
Krispy Kreme, Inc. ( DNUT ) stands to benefit from continuous price increases and an increasing point of access (POA) in the U.S. through its Deliver-Fresh-Daily (DFD) door expansion in QSRs, drug stores, and club stores, which should drive revenue growth. Additionally, the company's international expansion of global POA is expected to help increase its footprint and capture new markets to further support revenue growth in the long term. Price increases should also help offset inflationary headwinds in the near term, while cost savings through automation of after-bake doughnut processes and improving high-margin business mix are likely to support margin growth in the medium to longer term. However, DNUT's current valuation already reflects its long-term growth prospects, and the stock looks pricey trading at a P/E of 44.70x FY23 consensus EPS estimates. Therefore, given its high valuation, I would prefer to remain on the sidelines and rate the stock as neutral.
Revenue Analysis and Outlook
Since its IPO launch in July 2021, DNUT has benefited from an increasing point of access through its deliver-fresh-daily (DFD) outlets, both domestically and internationally, leading to strong sales growth. Additionally, good e-commerce sales growth during the pandemic has also contributed to revenue growth.
In Q4'22, DNUT's sales momentum continued, with revenue benefiting from an expanding global point of access, price increases, and strong demand during the fall and winter holiday seasons. As a result, DNUT reported a 9.2% year-over-year increase in revenue to $405 million. Excluding a 3.7% headwind from foreign currency and a 0.4% benefit from acquisitions, organic revenue increased by 12.5%. The results also reflect a 15% year-over-year growth in U.S. and Canada sales per hub to $4.6 million and a 7.7% year-over-year growth in international sales per hub to $9.8 million.
DNUT's Historical Sales (Company Data, GS Analytics Research)
Looking ahead, I believe DNUT should continue to deliver revenue growth with the help of price increases, expanding points of access through DFD, and international footprint expansion.
The company has taken several rounds of price increases during the second half of 2022, and management plans to increase prices further throughout 2023. The carryover impact of pricing from the second half of last year and additional price increases should help sales growth in 2023.
DNUT's key sales growth driver has been its continuous expansion of global point of access (POA), primarily through DFD outlets in convenience stores and grocery stores. The company has increased its global POA by approximately 40% to 11,837 since FY 2020, with a 50% increase in DFDs. The company aims to reach 75,000 POA globally over the long term, growing at a rate of 10-15% annually. According to management, the biggest issue the brand faces among consumers is the unavailability of Krispy Kreme donuts in their area. To address this issue, management believes that its Hub and Spoke model is the right fit to efficiently increase its presence in every market, and POA expansion should attract more consumers to the brand, given that the brand has good global awareness.
The company is targeting to unlock 15,000 POA opportunities across the U.S. by 2026. To achieve this, the company has started testing DFD rollout in QSRs, drug stores, and club stores, in addition to convenience and grocery stores. One example is the DFD rollout at McDonald's ( MCD ), which DNUT announced in October 2022, and has since expanded to 160 restaurants in February 2023. The donuts will be available in restaurants, drive-throughs, and McDonald's online delivery platforms, increasing availability in the area. McDonald's has approximately 14,000 restaurants in the U.S. So, if successful, the McDonald's DFD expansion could help Krispy Kreme easily achieve or even surpass its U.S. POA target.
Krispy Kreme POA Opportunity (Investor Day 2022, presentation)
Additionally, the company's focus on expanding POA internationally provides another good growth opportunity for Krispy Kreme. Outside of the U.S., the international and market development segment contributed to ~32% of total sales in FY22. Management believes that ~60,000 out of 75,000 POA opportunities they are targeting should come from existing as well as new markets outside the U.S. For 2023, DNUT plans to open 5-7 new countries and expand its footprint in 3-5 new countries every year beyond 2023.
Management has guided for 2023 organic growth of 9-11% with 8-10% reported sales growth due to FX headwinds. With the price increases and global POA expansion, I believe the guidance is achievable. The company's long-term growth outlook is also good, given its global POA expansion plans and increased sales per hub.
Margin Analysis and Outlook
Since the second half of 2021, the adjusted EBITDA margin has been negatively impacted by inflationary raw material and labor costs. Furthermore, in 2022, the margin was also affected negatively by unfavorable foreign currency exchange rates, as approximately 43% of the adjusted EBITDA comes from overseas. However, in the fourth quarter of 2022, despite the inflationary headwinds, management was able to offset them through price increases, lower G&A as a percentage of revenue, and volume leverage. As a result, there was a 90 bps year-over-year increase in the adjusted EBITDA margin to 13.8%.
DNUT's Historical Adjusted EBITDA Margin (Company Data, GS Analytics Research)
Looking ahead, the company may still face near-term headwinds from inflationary costs and adverse FX movements, but these headwinds are moderating, and the company is increasing prices to offset them. So, I am expecting margins to remain flattish sequentially around Q4'22 levels. However, due to easing comparisons, it still implies Y/Y growth.
In the medium to longer term, DNUT's adjusted margin is expected to benefit from improving its business mix as the company is permanently exiting its lower-performing hubs without spokes that generated low revenue and low margins. So far, DNUT has closed eight hubs without spokes and plans to close another 10 to 15 in the coming months. Additionally, the company is in the process of further automating its donut production at its hubs. The donuts after the baking stage required manual labor for icing, filling, and packaging, which comprised over $100M in annual spend on doughnut production labor in the U.S. By automating these after-bake processes, DNUT expects to reduce labor costs and support adjusted EBITDA margin growth in the long term. Overall, I am optimistic about DNUT's medium to long-term margin growth prospects.
Valuation and Conclusion
While DNUT's secular growth story of increasing POA's driving sales is attractive and the company can increase its sales at high-single-digit CAGR in the medium to long term, its valuation is not that attractive. The stock is trading at 44.70x FY23 consensus EPS estimate, which is a significant premium to most of its peers. Even Starbucks ( SBUX ) which has a track record of excellent growth and shareholder value creation is available at a lower P/E multiple (~31.54x FY23 P/E and ~26.35x FY24 P/E). There are associated risks as well. Rising concerns regarding health problems arising from sugary products may lead to demand softening in the longer term, and there is a possibility that the company may not be able to increase volume in line with POA growth. Given DNUT's extremely high valuation and current market conditions, I believe it is prudent to remain on the sidelines. Hence, I have a neutral rating on the stock.
For further details see:
Krispy Kreme: Good Growth Prospects But Expensive