What a brutal six months it’s been for Krispy Kreme. The stock has dropped 61.6% and now trades at $3.50, rattling many shareholders. This was partly due to its softer quarterly results and may have investors wondering how to approach the situation.
Is now the time to buy Krispy Kreme, or should you be careful about including it in your portfolio? Get the full breakdown from our expert analysts, it’s free.
Why Do We Think Krispy Kreme Will Underperform?
Even with the cheaper entry price, we're swiping left on Krispy Kreme for now. Here are three reasons why we avoid DNUT and a stock we'd rather own.
1. EPS Trending Down
We track the change in earnings per share (EPS) because it highlights whether a company’s growth is profitable.
Krispy Kreme’s full-year EPS turned negative over the last three years. We tend to steer our readers away from companies with falling EPS, especially restaurants, which are arguably some of the hardest businesses to manage because of constantly changing consumer tastes, input costs, and labor dynamics. If the tide turns unexpectedly, Krispy Kreme’s low margin of safety could leave its stock price susceptible to large downswings.
2. Cash Burn Ignites Concerns
Free cash flow isn't a prominently featured metric in company financials and earnings releases, but we think it's telling because it accounts for all operating and capital expenses, making it tough to manipulate. Cash is king.
Over the last two years, Krispy Kreme’s capital-intensive business model and large investments in new physical locations have drained its resources, putting it in a pinch and limiting its ability to return capital to investors. Its free cash flow margin averaged negative 7.6%, meaning it lit $7.63 of cash on fire for every $100 in revenue.
3. Short Cash Runway Exposes Shareholders to Potential Dilution
As long-term investors, the risk we care about most is the permanent loss of capital, which can happen when a company goes bankrupt or raises money from a disadvantaged position. This is separate from short-term stock price volatility, something we are much less bothered by.
Krispy Kreme burned through $137.2 million of cash over the last year, and its $1.42 billion of debt exceeds the $21.82 million of cash on its balance sheet. This is a deal breaker for us because indebted loss-making companies spell trouble.
Unless the Krispy Kreme’s fundamentals change quickly, it might find itself in a position where it must raise capital from investors to continue operating. Whether that would be favorable is unclear because dilution is a headwind for shareholder returns.
We remain cautious of Krispy Kreme until it generates consistent free cash flow or any of its announced financing plans materialize on its balance sheet.
Final Judgment
Krispy Kreme falls short of our quality standards. Following the recent decline, the stock trades at 4× forward EV-to-EBITDA (or $3.50 per share). While this valuation is optically cheap, the potential downside is huge given its shaky fundamentals. There are superior stocks to buy right now. We’d suggest looking at the Amazon and PayPal of Latin America.
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