Krispy Kreme Group Inc. Financial Analysis
The US Restaurant Industry
The restaurant industry is among the most important sectors in the US economy. As stated by the National Restaurant Association, the restaurant industry is the largest private employer. The National Restaurant Association projected that in the year 2012, the industry’s sales will increase to $600 billion. The $600 billion is an equivalent of 4% of the United State’s GDP. According to various analysts in the restaurant industry, it has been proved that about a quarter of Americans had their first careers in the restaurant profession. Currently, the industry employs about 13 million people, which is approximately 10% of the US workforce.
The US market is characterized by several competitive restaurants that earn high profits as compared to many firms in other industries. The top performers in this industry include White PLC, Greene King PLC, Mitchells & Butlers PLC, McDonald’s Corporation, as well as Domino Pizza UK & Ireland PLC. Other competitive firms in the restaurant industry include Dunkin Brands Group, Einstein Noah Restaurant Group, and Starbucks Corporation. Krispy Kreme competes with the above-mentioned firms in diverse markets located within the boundaries of the US.
McDonald’s Corporation, which operates at the global level, is the largest restaurant since its market capitalization is currently measured at 99.88 billion. The share price of McDonald’s is valued at $98.03, which is far much less as compared to that of Greene King PLC and Whitbread PLC. Whitbread PLC is the second largest firm in this industry given that it has a market capitalization of 3.27 billion. Its share price has also the highest value in the market given that its current value stands at $1,844 per share. Greene King PLC and Mitchells & Butter PLC follow in the third position with a market capitalization of 1.1 billion each.
Greene King PLC’s market capitalization is $513 while that of Mitchells & Buttlers PLC is $270.2. Among the top five companies in the restaurant industry, Domino Pizza UK & Ireland PLC has the lowest market capitalization. The company’s share price is $442.86 while its market capitalization is valued at 715.21 million. Behind Domino Pizza UK & Ireland PLC is Krispy Kreme Doughnuts with a market capitalization of 508.34. The company’s shares trade at the lowest value of $7.33.The restaurant industry is very promising considering that in the year 2011 all companies had quarterly revenue growth of more than 8%. Dunkin Brand Group experienced a quarterly growth rate of 12.5%. In the year 2011, Dunkin Brand Group closed the financial period with a net income of 34.4 million
Where,
- DNKN = Dunkin’ Brands Group, Inc.
- BAGL = Einstein Noah Restaurant Group, Inc.
- SBUX = Starbucks Corporation
Krispy Kreme
Krispy Kreme is an international chain of doughnut stores that is based in Winston, North Carolina. The company started its operations in 1937 in a building that is today known as the Old Salem district. Vernom Rudolf, the founder of this organization, began the operations of the restaurant in Wenston Salem, a region found in North Carolina. Currently, the company trades its shares in the New York Stock Exchange using the ticker symbol KKD. Since its inception, Krispy Kreme is known for its quality doughnut. In the US, Krispy Kreme sells its products in-store locations, gas stations, grocery stores, supermarkets, and Wal-Mart, among other places.
Before Krispy Kreme went public, the company recorded a high growth that was attributed to strongholds in South Carolina. However, after the company began trading its shares in NASDAQ and later in NYSE, its shares were progressively indicating signs of decline. Although the company operated within the borders of the US, the company today claims a substantial part of the international market. Krispy Kreme has business segments in several countries including the Philippines, Japan, England, and Canada. Although the restaurant industry has become very competitive in the contemporary world, Krispy Kreme managed to record a profit amounting to $7.6 million at the end of the year 2011. With 3,700 employees, the company’s revenue stood at $362 million at the end of the financial period 2011. The company continues to specialize in doughnuts, soft drinks, hot drinks, and sausage.
Competitors
Direct Competitor Comparison
Initial Public Offering and the accounting Scandals
The company began trading its shares in the NASDAQ stock exchange using the ticker symbol KREM. However, in mid-2001, the company enlisted its shares in the NYSE using the ticker symbol KKD. The shift from the NASDAQ to New York Exchange led to miserable events that surrounded its operations. The company lost almost 80% of its share value by the end of the year 2005. The loss of stock value was associated with the company’s decline in earnings. The loss of the equity value was also attributed to the SEC investigation, which was conducted to confirm allegations concerning the accounting malpractices.
Given that the company went public in the year 2000, it is no doubt that this was the first time the company lost its stock value as a public company. Although the Chief Executive Officer of Krispy Kreme claimed that the company suffered the loss because of the low carbohydrate diet craze, a good number of analysts dismissed the statement since other similar companies in the industry did not suffer the low carbohydrate tendency within the same duration. An example of a doughnut chain that did not suffer the same trend includes Dunkin Donuts.
According to the CEO, the company had expanded hastily following the IPO. This encouraged the chain to concentrate on coming up with various stores in the market. The Chairman stated that the rapid expansion initially contributed to substantial profit. However, there was stiff competition between franchisees that were primarily competing for profitability. Although the company grew at the parent level due to the royalty payments made to the parent company by franchisees, the new franchisees continued to record declines in sales. Notably, in 2004, the parent company experienced an increase of 15% in revenues while the franchisees only witnessed a 10% increase.
Other companies in the restaurant industry focused on increasing profitability at the franchise level. Such restaurants in the industry included McDonald’s. Various analysts claim that supermarkets and gas stations contributed to the Krispy Kreme saturation in the market. This is because the stiff competition was created amongst the new franchisees. As a result, Krispy Kreme’s strong brand image lost its popularity.
Apart from the royalty payments made by the new franchisees, the parent company realized substantial revenues through instructing the stores to buy the doughnut-making apparatus from the headquarters where the parent company is located. The franchisees were required to acquire pieces of equipment that could be used in production from the parent company. These pieces of equipment were to be purchased from the Krispy Kreme division commonly known as the Manufacturing and Distribution division. In total, the Manufacturing and Distribution segment earned Krispy Kreme an amount worth $152.7 million.
The annual report indicated that the Manufacturing and Distribution segment contributed to 31% of the total sales made by the company. However, the sizeable revenue was gained at the expense of the franchisees. In contrast, other chains in the industry such as Mcdonald’s avoided selling materials to their franchisees. Several concerns regarding the rights of franchisees were aired in various media. The media alleged that the interest of both the parent company and the franchisees should be aligned to ensure openness. Krispy Kreme was accused of questionable business deals and transactions.
Further Analysis of Krispy Kreme Accounting Scandals
Krispy Kreme had become an attractive company for the majority of the shareholders after it went public in the year 2000. In November 2001, the company’s shares had hit a value of $108.5. However, the management considered splitting the stock into two. This meant that every share was valued at a new price of $54.25. During the investigation that was carried out by the US Securities and Exchange Commission, the company’s financial strength began to weaken. It was in March when the Securities and Exchange Commission ordered three executives to pay a total amount of $783,000 for displaying accounting misconduct. The three top executives included Mr. Scott Livengood, who managed the affairs of the company as a CEO, chairperson, and president. The two other executives were Randy Casstevens, the CFO, and John Tate, the chief operating officer (COO).
The inflated sales
The company was accused on several occasions of issuing false financial statements that misguided the public. Both the former chief operating officer and the chief financial officer were alleged to have participated in the delivery of over 470,000 shares of the company’s equities for a figure amounting to $19.8 million. In contrast, the public was aware that the company’s sales were declining at a high rate as at the end of the year 2004.
One of the employees of Krispy Kreme provided the SEC with some information regarding orders that were shipped to various customers and retail premises. According to the employee, the company had double-shipped orders to customers on five occasions. During the fiscal year of 2004, one of the Krispy Kreme managers was witnessed instructing employees to deliver double orders to retail customers. However, the doughnuts were to be returned for credit early the following year. These transactions were made at the end of the year to meet the estimates outlined by Wall Street.
Several analysts in the industry argue that the auditing company, Price Water House-Coopers, should have known that there was a connection between the high volume of sales at the end of the year and a similar amount of credit in the following year. Large monthly variations should also have given PWC a clue of accounting malpractices displayed by the management.
Accounting irregularities
There were some suspicions over the inflation of profit after Krispy Kreme purchased back a Michigan franchise for $32 million at the end of the year 2004. The Price Water House-Coopers had rejected signing off the quarterly based results. The US Security and Exchange Commission accused the PWC of failing to identify malpractices concerning the inflated sales. If the PWC had signed off the accounting methods then it would have appeared that PWC signed off the financial statements based on immateriality. However, according to the act provided by the Sarbanes-Oxley, PWC had the profession and expertise to detect any accounting misconduct as was displayed by Krispy Kreme. Some speculators claimed that Krispy Kreme would select another auditor at the market to calm down its investors. However, it would only look for a new auditor after issues concerning the mismanagement and accounting malpractices had been settled.
Management accountability
At the age of 52 years, the former CEO Scott Livengood announced that he was retiring as the company’s chairperson, president, and CEO. His announcement regarding the retirement came in amid allegations concerning the disguised volume of sales on the financial statements issued by the company. A famous turnaround specialist Mr. Stephene Cooper replaced Scott. Cooper had helped in the Enron reorganization after the corporation was declared bankrupt.
The retirement of Scott left him with an option to purchase about 330,125 shares. According to Sarbanes-Oxley Act, the executives were eligible for punishment due to signing off the financial statements. The senior management had full information regarding the actual financial results. Various individuals in the senior management office in the accounting department were to quit office to pave way for smooth and transparent investigations given that the department should have been questioned about the over-shipments and high levels of credits.
The 2005 turnaround strategy
Following the declines witnessed in its shares, the company decided to reshuffle the management. The old management was perceived by the public as the type of management that was characterized by fraud and misconduct. At the beginning of the year 2005, the company chose Stephen from the financial consulting group known as Kroll Cooper, as the new acting CEO. Stephen replaced Scott Livengood who retired as both the chairperson and CEO. The managing director of Kroll Zolfo, Mr. Steven Panagos was named the COO of the company. This plan was carried out to close down the loss-making stores. This would entirely lead to the avoidance of insolvency in the future.
The Company’s Financial Performance
In the year 2009, the company was suffering from several financial difficulties. The company made a loss amounting to $4.061 at the end of the financial period 2009. The firm started to regain its financial strength in the year 2010 after its losses reduced to $0.15 million. The net income of 7.599 million at the end of the financial period 2011 indicated that the company had fully recovered from the financial turmoil that was surrounding its operations.
For the last two years, Krispy Kreme did not suffer from the costs arising from revenues. The company had huge losses relating to the revenue costs. While there was no loss associated with the revenue costs in the years 2009 and 2010, the company incurred a total revenue cost of $345.007 million. These revenue costs led to the poor performance of the firm. The company also faced heavy costs in selling as regards general and administrative expenses, which totaled $371.504 million (Wittner 32).
However, the company indicated a unique performance for the last three years. While the company indicated high losses in the year 2009, the management startled the public by the amount of cash and cash equivalents it had at the end of the same period. Krispy Kreme management afforded to realize a change in cash and cash equivalents amounting to $10.803 million. In the year 2010, the company’s change in cash and cash equivalents was valued at a negative of $15.323 million. However, the company indicated a positive increase in 2010 after it recorded a change of cash and cash equivalents worth $1,755. The firm’s cash flow from operating activities indicated a progressive improvement. The company’s cash flows from operating activities improved from 16 million in the year 2009 to 19 million in the year 2010. The cash flow from the operating activities improved to 20 million in the year 2011.
With its current market capitalization of $513.91 million, Krispy Kreme has managed to attain a quarterly revenue growth rate of 11.20%. The company’s enterprise value per revenue was measured at 1.25, while enterprise value per EBITDA was valued at 14.51. Although the price per sale indicated a figure of 1.29, its price per book indicated a higher value of 2.08. The firm continues to struggle in the market to ensure that the value of its shares gains public confidence. This indicated a progressive price per earnings ratio. The current P/E is valued at 3.17. The company’s effort is also indicated by the improvement in the entity’s returns on both assets and equity.
Return on assets indicated a promising figure of 6.53% while return on equity was valued at 102.15%. This financial performance indicates that the company is recovering from the financial recessions that hit the industry for a good part of the last 5 years. Analysts and experts in the restaurant industry state that most firms are expected to grow at the pace required by the industry. Investors gain more confidence due to this. Krispy Kreme expects its revenue to double in the next three years. This will attract more investors given that the new management is pursuing the best approaches in the industry to ensure that the company attains a competitive edge.
Income Statement
Balance Sheet
Cash Flow
Adjusted Return on the Market Stock
Where:
- KM: market return
- KRF: Return on risk-free asset
- K Krispy: Return on Krispy Kreme’s stock/assets
Beta Graph
Y-axis: Stock return
X-axis: Risk premium
Beta = 2.06
Return on Krispy’s assets = 6.1%
Return on risk free asset = 3.12%
Future Values and Present Values of Cash Flows
($ ‘000’)
Present Value = Future Value/ (1+ rate of return) ^n where n is the number of years.
Required Rate of Return = 6.1%
Total present value of projected cash flows = $143,557
Cost of capital
Cost of debt
The cost of debt is calculated is normally calculated on loans, debentures, and bonds by multiplying the interest rate with the total debt. The cost of debt is also denoted as Kd.
Cost of Debt (Kd) = Interest amount/ (Amount of debenture + Amount of premium) X 100
Cost of Debt (Kd) = Interest Amount/ (Amount of Debenture – Amount of Discount) X 100
The first formula implies that the bond is issued at a premium while the formula means that the bond is issued at a discount.
However, in situation where there is cost of equity, incorporation of tax rate is necessary.
Cost of Debt = Amount of Interest (1 – Tax Rate) / Amount of Loan X 100
Kd = 1,666,000(1-0.2)/25,369,000* 100
Kd = 5.25%
20% is the marginal tax rate.
The amount of interest is found on the income statement while the amount of the loan is found on a balance sheet.
Cost of Equity
Cost of Equity, Ks= Rf + (Rm – Rf) Beta
Where Ks= cost of equity
Rf = risk-free rate. In this case interest rate on the US treasury bills is used.
Rm= Market rate of return
Beta= risk of company’s stock in comparison to that of the market
Ks = 2.991 + (4.12-2.991)2.06
Ks = 5.37%
Weighted Average Cost of Capital
The firm chose to distribute its capital based on 10% on bonds and 90% on equity. Therefore, work would be:
WACC= Ks*Ws + Kd*Wd
WACC= 5.37*0.9 + 5.25*0.1
WACC=5.36%
Dividends Policy
The company has a special dividends policy that distinguishes it from other companies. Unlike other companies, which consider paying dividends in form of stocks, Krispy Kreme has resolved to stick to cash. Krispy Kreme understands that paying stocks, as dividends will most likely dilute the shares of the company. The dividends of the company are expected to increase from $7.3 to $14.5 in the year 2012, and finally reach $21 in the year 2013.
This improvement is expected in the next 5 years. The expected increase is attributed to the projected increase in the share value of the firm soon. The firm pays its dividends quarterly. The last ex-date was on 02/9/12 and will subsequently be made after March. The dividends are normally paid from the profits made by the company. Krispy Kreme realized that delaying dividends payment would negatively affect the image of the company. This may lead to a fall in its share value. In this regard, the company always pays dividends in time.
Conclusion
Krsipy Kreme Group Inc faced financial difficulties after it went public in the year 2000. The company enlisted its shares in the NASDAQ stock market before moving to New York Stock Exchange in 2001. The company indicated substantial value on its share that attracted various investors. In the year 2001, the New York Stock Exchange valued the company’s share at $108.5. However, the company split the share hoping that the company will be able to avail more stocks at the market. It is expected that it would easily raise adequate capital using many shares in the marketplace. It also aimed at reducing influence on management by a small number of people.
The US Security and Exchange Commission managed to carry out an extensive and impartial investigation that led to several convincing results. The SEC indicated that the senior management was liable for a fine or any form of punishment given that they signed off knowingly on wrong financial statements. The SEC also accused Price Water House-Cooper of failing to identify the monthly variation of sales. With the profession and expertise that Price Water House-Cooper has, the SEC expected that PWC would be in a position to identify huge sales at the end of the year and corresponding high levels of credit early the following year. In the end, the SEC ordered the three top executives to pay $783,000 for allowing accounting malpractices in the company.
It was in March 2005 when the Securities and Exchange Commission ordered three executives to pay a total amount of $783,000 for displaying accounting misconduct. The reshuffling of the company’s management was the only solution for the mismanagement of the company’s accounting. The new CEO and chairperson is a popular turnaround strategist who assured Krispy Kreme of better performance shortly. The practices of cosmetic accounting are done with different intentions including fraud and increasing investors’ confidence. The various financial analyses done on this paper indicate that Krispy Kreme is one of the promising companies in the restaurant industry.
Although Krispy Kreme can be perceived as a weak company when compared to the top performers in the industry, an individual who does an extensive analysis will realize that Krispy Kreme will grow at a fast pace. Many analysts in the market state that Krispy Kreme is expected to grow at a faster pace relative to that of the industry. Regardless of being ranked number 42 in the market in terms of market capitalization, the company emerged third in the entire industry in terms of long-term growth rate. The company was also ranked sixth in the industry after indicating a high growth rate on its quarterly earnings per share. Out of the 98 companies in the restaurant industry, Krispy Kreme was ranked 26th after indicating a return on equity of 102.15%. The company has also shown strong performance on quarterly revenue growth rates. The company’s quarterly revenue grows at the rate of 11.20%.
Works Cited
Wittner, Peter. The European Generics Outlook: A Country-by-Country Analysis of Developing Market Opportunities and Revenue Defense Strategies. London: Datamonitor, 2003. Print.
Appendices
Comparison of Competitors
Krispy Kreme. Final Pro-former Income Statement
For the year 2013, 2014 and 2015 ($ ‘000’).