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Doughnuts Are a Steep Investment

What could be better than writing about doughnut stocks? How about writing about doughnut stocks while stuffing my face with a chocolate-glazed, crème-filled snack? Don’t worry about bias — I’m enjoying the product of a privately held company.

I had never had a legendary Krispy Kreme (NYSE:KKD) doughnut until about 10 years ago. No stores existed in my area — then, like magic, they sprouted up all over the place. This was right about the time KKD went public. Those with good memories remember accounting problems hammered the stock. The question is whether Krispy Kreme has regained its footing, especially now that it has competition in the public stock markets. The good news is that all these issues were put to rest in 2007, so we’re far enough out to be able to evaluate KKD on its merits.

You might be surprised to learn that Krispy Kreme is primarily an international phenomenon. The company only has 230 U.S. stores and 417 internationally franchised stores. KKD’s balance sheet is very solid, with $38 million in cash and only $25 million in debt, and it generates a modest $18 million in trailing 12-month free cash flow. Earnings are set to double this year, then slide down to more modest growth of 10% next year, and KKD trades at 26 times 2012 earnings.

It’s important to note that Krispy Kreme is coming off of a multiyear turnaround, and that much of its success depends on its loyal fan base. It does offer a product that, to most, is quite different from its competitors. Serious investors should read this case study that lays out more information about Krispy Kreme that I found useful. It’s also a bummer to note that mutual fund legend Ron Baron, who was so high on the company initially, doesn’t own the stock anymore. I think it’s pricey, I think there’s a lot of competition, but I think that over the very long haul, KKD could turn into something bigger.

The loyal fan base alone suggests it might even be a buyout target at some point, perhaps by a Starbucks (NASDAQ:SBUX). Robert Stiller, the Founder & Chairman of Green Mountain Coffee Roasters (NASDAQ:GMCR) owns 11.8% of KKD’s stock. An acquisition would make sense here, too, although I can’t see much of a premium from here.

In the other corner we have Dunkin’ Brands (NASDAQ:DNKN). Here is a massive operation of 9,800 Dunkin’ Donuts stores and — whaddya know — 6,400 Baskin-Robbins ice cream stores, too. The company’s balance sheet is OK, with a quarter-billion in cash offset by $1.45 billion in debt, and DNKN generated $163 million in free cash flow last year. The franchise model is a good thing here, as it doesn’t require the company to barf up a lot of cash for expansion, and it collects those royalty fees every month. Overall, the company saw a 5.1% comp sales increase on the doughnut side but a measly 0.5% increase on the ice cream side.

Dunkin’ Brands trades at 24 times 2012 estimates, and I think that’s also very pricey for a space with so much competition. If DNKN can break further into the lunch market along with its successful move into breakfast, I think that’s the key to its success.

For now, I’d suggest staying away from both company stocks — but I would gobble up their culinary offerings.

As of this writing, Lawrence Meyers did not hold a position in any of the aforementioned securities. He is president of PDL Capital, Inc., which brokers secure high-yield investments to the general public and private equity. You can read his stock market commentary at He also has written two books and blogs about public policy, journalistic integrity, popular culture and world affairs.

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