Krispy Kreme Case Study

Krispy Kreme

SCOPE

The scope of this report is to analyze Krispy Kreme Dounghnuts’ (KKD) financial statements, supported exhibits, and business plan to evaluate the impact of earnings analysis announcements on the stock price for 2003-2004.

KRISPY KREME’S COMPANY BACKGROUND

In 1937, KKD began as a single doughnut shop in North Carolina, selling doughnuts wholesale to supermarkets. The popularity of the product not only caused KKD to become a factory-like retail store but also led to the franchise of more stores to mostly franchisees. It was later purchased by Beatrice Foods, in 1973, who expanded it to 100 locations. Beatrice Foods also “introduced other products such as soups, sandwiches, and cut costs by changing the appearance of stores and substituting cheaper ingredients”. The business however did not flourish as expected, and was sold to a group of franchisees led by Joseph McAleer in 1982 for $24 million. McAller led the KKD back to using the original doughnut formula and the company’s traditional logo; in addition McAller introduce the “HOT DOUGHNUTS NOW” sign, which successfully told customers when fresh doughnuts were coming off the line. KKD continued to struggle but did expand slowly and became debt free in 1989. In 1998, Scott Livengood became CEO of KKD and took the company public on April 2000, and on the next day of public offering the company share price was $40.63, “giving the firm a market capitalization of nearly $500 million”. KKD generated revenues through four primary sources: retail stores, franchisee stores, off-premises sales to grocery and convenience stores and gas stations, and by manufacturing and distribution of machinery and product mix.

FINANCIAL RATIO ANAYLSIS

In order to understand KKD’s financial standing, it is a good ideal to compare its financial ratios to the industry average. The industry average ratios will be compromised of similar quick service restaurants, as stated in Exhibit #8, excluding KKD’s values. Also, any largely deviated values within the industry companies will be omitted, which are mostly likely results of rare one time occurrences.

The current ratio and quick ratio for KKD in FY2003 are 3.25 and 2.72 respectively. These amounts are much higher than the industry norms of 0.98 and 0.50 respectively. In FY2000, KKD’s current ratio was only 1.41. This shows that KKD only has to be able to convert each dollar of current assets into at least $0.31 of cash to be able to pay off their current liabilities. These liquidity ratios are positive because they can justify to short-term creditors that KKD is well worthy of short-term loans. However, further investigation may be needed find out why KKD’s current assets are too high.

LEVERAGE RATIOS

As for leverage ratios, it is important for a company to find its optimal balance between debt financing and equity financing, because there are pros and cons to both. Too heavy weighted debt leaves companies vulnerable to creditors if stock prices drop drastically and too much equity financing may become more costly because of dilution of shares and earnings. In this case, in FY2003 KKD’s long-term debt to total capital is 10.12, while the industry norm is 30.75. and KKD’s long-term debt to equity ratio is 11.26 while the industry norm is 33.35. These values show that KKD has much more capacity for long term finances than most of its competitors; and in general terms, a long-term debt to total capital ratio of 10% is relatively low for any company in an expansion phase. From a creditors view, this value may seem positive, but from an investors view it may looked at as unused leverage.

The Assets to equity ratio also further emphasizes that KKD has more capacity of safe financial leverage. KKD’s asset to equity is 1.46 while the industry average is 2.2.

ASSET MANAGEMENT RATIOS

The following asset management ratios will be important in showing how KKD invests in its groups of assets relative to the revenue the assets are producing. The cash turn over is slightly lower than the industry average at 32.79 to 33.4 in FY2003, but this difference is minimal in comparison. The following chart below also displays other turnover comparisons.

The inventory turnover and receivable turnover are significantly below the industry average. The inventory levels at KKD are obvious too high in relation to sales and may be stemming from poor management of inventory, and this is holding up potential funds that could be invested elsewhere.