Krispy Kreme Doughnuts, Inc. (KKD) operates under the restaurant industry as a branded retailer and wholesaler of doughnuts. The company’s conducts its business by owning and franchising Krispy Kreme doughnut stores with over 20 varieties. The said doughnuts are the considered the company’s primary products, which are made, sold and distributed together with array of coffee and other beverages. It has an estimated 4,000 employees and more than 400 Krispy Kreme stores system-wide in various states of the United States, District of Columbia, Australia, Canada, Japan, Mexico, Philippines, Kuwait, Mexico, and other countries.
It owns more than a hundred of the total operated stores while the rest were by franchisees. Less than 300 constitute factory stores and the rest are satellites (MSN, 2009; Krispy Kreme Doughnuts, 2009a). KKD’s primary competitors include Starbucks Corporation, and Tim Hortons (Yahoo Finance, 2009a). This paper analyzes the financial performance and situation of KKD and compares the same in relation to some it competitors. It also discusses its available real options, how the company manages the effect of US-dollar-value fluctuations to its business, and how it deals with the effects of tight credit markets.
Further discussions extend to how it manages the effects of global rise in commodity prices and how it deals with a current event that is affecting the company. The paper will make the necessary conclusion out of the discussions as basis for recommending whether there is basis to buy, sell, or hold stock investment with the company. 2. Financial Analysis To get an instant picture of how well the company does in terms of its finances necessitates a financial analysis by using its financial ratios as summarized in Table A below. This part is segmented into profitability and efficiency, liquidity and solvency analysis.
2. 1 Profitability and Efficiency The company’s returns on equity (ROEs) for the past five years show very low profitability with negative annual average of 70%. It was only in 2004 that KKD was able to reflect a positive ratio in comparing the years recorded. It must be noted that computed ROE is the same the Return on Common Equity due to the fact the although the company is authorized to issue 10,000 preferred shares, KKD has yet to issue some share to indicate changes in the share of the common commons stockholders . Please refer to Table A.
To have such a negative 70% annual average means that something must be wrong with company since the same could indicate a continued loss of money from the investors or stockholders from the past four years at the average rate 70 US dollars for every 100 US dollars made in investment. It must even be a surprise why the company has continued to exist until this time without the company needing to cease operation by bankruptcy or otherwise. The company will definitely sound like an investment to avoid. Its negative profitability if compared with industry average for ROE at 23. 1% (MSN, 2009b) is very alarming.
To compute return on equity, one needs the formula whereby net profit is divided by the total stockholders equity which means that profits is being related with how much was put it. Compared against a US Federal Reserve Bank base rate of 0. 25% (Housepricecrash, 2008), which is an estimated risk free rate when making investment in a US treasury bill, the company’s negative profitability in terms of latest ROE is still inferior. This could mean that investors would have rather kept their investment with a risk free treasury since even if they do nothing they will still earn money.
It is therefore a big surprise that investors are not selling their investments from the company that may be caused by further losses. Its negative profitability appears supported also by its operational inefficiency. It’s operating margins averaged negative 9% for the last five year. If compared with its net profit margins for the last five years which registered an average of negative 13%, the company may be considered to be furthering its losses from other non-operating sources. Please refer to Table A above.
Its operating margins which averaged at negative 14% is derived after deducting cost of sales or services and operating expenses from the total revenues and dividing with total revenues (Meigs and Meigs, 1995) Since the said ratios are negative, it would mean the company is also inefficient. This could mean that the company’s managers and employees are being paid continually despite its continued losses. This therefore makes it operation very uncertain. The company’s operational inefficiency is verifiable by looking at the fixed asset turnover ratios and the asset turnover ratios of the company, which averaged at 2.
16 and 1. 45 respectively. Fixed asset ratio of 2. 16 would mean that the company has not been utilizing well its fixed assets to generate revenues. It would mean that for every 100-dollar investment in fixed assets, the company would take not more than three to generate corresponding amount in revenues. The same may be said of it total asset turnover which averaged at 1. 45 for the past five years. Refer to Table A. Such a situation would in fact show that the company is not generating enough revenues to compensate the utilization of its assets.
The lower total asset turnover ratio than fixed asset ratio would mean that the company’s use of fixed asset may be improving the company’s efficiency, but the same could not be considered success because of the negative net profit margin for the last four years. Refer to Table A. 2. 2. Liquidity Liquidity ratio guides a company to know whether it is able to meet a company’s currently maturing obligations. It is usually determined by using the current ratio and the quick asset ratio. As applied now, the current ratios of KKD averaged at 1. 41 while its quick asset ratios for same years averaged at 0. 98.
Refer to Table A. Both ratios indicated fluctuating behaviors for the five years under review where both increase and decrease were recorded. The results appear surprising considering that the company has negative profitability. It could mean that the company’s unprofitable operation has not affected much the company’s still acceptable liquidity and that the risks of bankruptcy has so far prevented since the company appeared to have been capable of paying its creditors on time. KKD’s liquidity is even higher than industry average of 1. 2 (MSN, 2009c) which makes it an issue of reliability of the financial statements.
2. 3 Solvency Liquidity assures the short-term while solvency assures the company’s long-term capacity to keep up it stability over the long term. Two ratios to measure solvency includes debt equity ratio and debt asset ratio or debt ratio. Debt to equity ratio as computed by having the total debt of the company divided by its total equity, said solvency ratio basically guides investors that the company needs to have a long life to recover long-term investments, which takes years to produce the needed returns. The debt to equity ratios of KKD averaged at 2. 06 for that past five years.
Please refer to Table A above. The ratios are quite high since almost every single year, except in 2004 and 2005, the ratio has exceeded 1. 0, which indicates the company’s investment from stockholders is not adequately covering borrowings. Debt ratio uses total asset divided by the total assets. KKD’s debt asset ratio also showed increased consistently from 2004 through 2007 and decreased in 2008. It must be noted that both debt to equity ratio and debt ratio would be better if the same are lower compared with other ratios. This must be so since the ratios measure risk and the lower the ratio, the lower risk.
The lower the risk the better is the expected returns of the investments. It can be noted that the changes in the debt to equity ratios showed deterioration from 2004 down to 2007 with only a little improvement in 2008. How the average was still more than four times the 2004 level of 0. 50. The deteriorations noted could be attributed to the continued negative profitability of the company for the last four years starting in 2005. As an overall assessment however, the company may not l be considered as solvent and therefore may not be possessing good long-term health as justified by its continued lack of profitability from 2005 through 2008.
However, the notably maintained and acceptable liquidity position of KKD may be still saving the short-term life of the company and which may have prevented the company from bankruptcy. This could mean that the company was still able to pay the operating expenses including current liabilities on time and that working capital appears still adequate to continue with the business. 3. A benchmark comparison of your company to its two primary competitors and its industry Based on profitability ratios, the company is less profitable than two of its direct competitors Starbucks Corp. and Tim Hortons, Inc. See Appendix A.
These ratios could be verified beginning from gross margin to operating margin and even net profit margin where the company has shown substantially lower rates than direct competitors . Tim Hortons’ return to equity for the latest twelve months was reflected at 26. 57%, Starbucks’ at 7. 10% while that KKD was at negative 48. 33%. In terms of liquidity ratios however, the company is better than two of its direct competitors are.
KKD has shown current ratios of 1. 9, which is far better than Tim Hortons’ 1. 27 and Starbucks’ current ratio of and 0. 867. Again the better liquidity of the company despite its poor liquidity is raising some doubts on how reliable are its financial statements. This must so in the light of its least amount of cash from operation of only $12. 38 million as compared with Tim Hortons’ $279. 39 million and Starbucks’ $1. 14 billion. No wonder the company has the lowest market value among the three companies. A more relevant comparison with competitors is more evident in terms of comparing their stock prices as shown in Figure I below.
As could be seen above, KKD performed obviously less favorable than Starbucks and Tim Hortons since 2005. This means that the company could hardly compete with its competitors because of its very low profitability. The better liquidity of the company is a less relevant influence on the stock prices of the companies. Stock prices are better influenced by the profitability of the business. The reflection of the stock prices in the stock market as shown in graph is a more reliable basis for measuring the company’s worth.
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