Krispy Kreme Stock Is Back. How Tasty Does It Look?

After a five-year hiatus from public markets, Krispy Kreme (NYSE: KKD) is back, selling more than its doughnuts to investors. But has this special treat gone cold? In this episode of Industry Focus: Consumer Goods, join Motley Fool analysts Asit Sharma and Emily Flippen as they unpack this 83-year-old business and discuss if you should buy its stock…or just stick to its original glaze.

This podcast was recorded before Krispy Kreme started trading on July 1.

To catch full episodes of all The Motley Fool’s free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.

This video was recorded on June 29, 2021.

Emily Flippen: Welcome to Industry Focus. Today is Tuesday, June 29, and I’m the host of this episode, Emily Flippen. Today, I’m joined by Motley Fool senior analyst Asit Sharma, to take a big bite out of an upcoming IPO, Krispy Kreme. Asit, I’m really excited for this one.

Asit Sharma: Emily, I am, too. What a fun IPO to discuss, not to say that the other IPOs we’ve looked at so far this year haven’t been exciting in their own way. But this one hits close to home on so many levels for me and for you.

Flippen: Yes. I have some strong opinions as I know we’ve discussed personally before about doughnuts. I’m weird in the fact that I’m not a huge doughnut fan, I don’t particularly like them. Cake doughnuts are OK. I’m not a big fried-dough person, but more importantly, there’s a very particular way that one should spell doughnuts, and it’s spelling out dough-nuts, not do-nuts. I hate the culture that we’ve created we’re spelling out doughnuts, “donuts,” it’s somehow acceptable. I have to tell you, when I was sifting through this S-1, I was already looking fondly on Krispy Kreme, because they spell doughnuts correctly throughout the entire report, so off to a good foot here.

Sharma: They are coming back to the markets with some integrity. I, too, am a fan of the D-O-U-G-H spelling. But you know, Emily, the executives at Dunkin Donuts will disagree with this. As you and I saw on our live show, Motley Fool Live, several weeks ago, most of the doughnuts shops in Texas, where you’re from, prefer the D-O-N-U-T spelling, so I think we’ve got to live with it, but we’re going to give Krispy Kreme some points right off the bat for getting it right.

Flippen: I will live with it, but I will loudly live with it. I will call it out whenever I see it, I will be the most annoying person to have in your doughnut shop wherever I’m in Texas.

Sharma: You go.

Flippen: We do have the preliminary prospectus for Krispy Kreme and I actually wasn’t aware, I think of what I’ll call a checkered history for Krispy Kreme. It was originally a public company, I think it was brought public in 2000, then taken private in 2016 after a dozen or so years of really challenging times. They’ve been through a lot. You, Asit, being more familiar with the history of Krispy Kreme, let’s talk a little bit about where Krispy Kreme has been before we get into where it’s going.

Sharma: Krispy Kreme, Emily, was founded in 1937 in Winston-Salem, North Carolina, which happens to be about three hours west of where I live in Raleigh, North Carolina. For a long time, it was a chain which was associated with treats here in the South, and they gradually started to branch out. In fact today, the company has a surprisingly strong presence on the West Coast, but there’s a lot of white space in between. In the period that you’re talking about, the company grew, as you said, through franchise groups which were often competing. The franchisees went through bankruptcies, some had trouble expanding northward, which has always been a task for Krispy Kreme to generate some true momentum outside of its Southern roots, where a good fried piece of dough is par for the course in your daily caloric intake. You pointed out when we were prepping for this show that one of the problems the company faced during the period of the early 2000, was that it lacked internal controls. They had a number of CFOs who came and went, and as a public company, they were really flailing. In fact, you’ve mentioned to me that in 2005, they had 420 stores across 45 U.S. states, and they had all methods of distribution.

If you looked around, I think, at that point in time, it was hard not to see a Krispy Kreme doughnut in many parts of the U.S, whether you’re in a grocery store or driving around in a decent-size city in a convenience store, et cetera. 2016, enter a German family investment firm known as JAB, which has been on a mission since I would say the 2010s to try to take market share in the coffee market from companies like Nestle and Starbucks. Every company that they’ve bought in the U.S. — and they’ve picked up a ton of consumer goods companies — has some link to coffee. JAB Holdings owns Pret-a-Manger now; Peet’s Coffee, which is a West Coast chain, found in grocery store shelves; Einstein Bros. Bagels; Panera Bread, they even own one third of Keurig Dr Pepper. In part of this roll-up that JAB Holdings embarked upon, mostly in that 2015 range onward, Krispy Kreme seemed a really important component because it was a company that was well situated in the parts of the South that I’ve mentioned, but also had a coffee business — and has a coffee business.

The surprising thing to me, which we don’t have time to get into this episode today, Emily, is why the company did not invest in the coffee strategy, which Krispy Kreme actually was starting to put some thought into around this time period. However, they took the company private in 2016. Basically, took full control of Krispy Kreme, and now, they are bringing it back to the market. Krispy Kreme is going public again. Likely in the next few weeks. JAB Holdings will maintain about a 40% share of the company after it sells its shares to the public. I think that this new phase of Krispy Kreme as a public company again should be very interesting because some things have changed about the business in the years since JAB acquired the company. I think they brought their expertise and discipline to Krispy Kreme. We’ll get into that. But Emily, how about some overview of the company’s business, exactly how it operates its business model?

Flippen: Yes. What I love about doing this show is that we didn’t really need to provide any introduction when we said Krispy Kreme. I think everybody listening probably already has a sense about what Krispy Kreme does. In fact, one of the metrics they used in their S-1 was that they had 94% aided brand awareness in all of their target markets. Meaning, when you walk up to somebody on the street and you say, “Hey, you want to go to Krispy Kreme?” They’re like, “Oh yes, that doughnut place. Sure.” Like that’s the process that somebody’s mind goes through. So I think most people have some sense of the business. They sell their doughnuts, mainly, through their retail stores, but they’ve increasingly changed the way they targeted their market, which goes back to some of what Krispy Kreme has experienced in the past.

You mentioned that they were distributing to convenience stores, truck stops, supermarkets, all these places where people could casually walk in and grab themselves a doughnut. It was an interesting decision that management made, and I think it’s probably a bad one because Krispy Kreme is known for the quality of their doughnuts. It’s an indulgence. It was a business model that, at the time, I think maybe devalued the brand a little bit. What Krispy Kreme is in the business now is changing the way that they distribute to third parties. They’ve renamed it. I’m not sure if it’s actually changing it much, but they renamed it to what they call delivered fresh daily — their DFD model — where they’re essentially using little hubs of Krispy Kreme Creations to then distribute to these third parties. These hubs are often called the Hot Light Theater shops, which I have my own qualms with, but I’ll leave that on the table there. These Hot Light Theater shops are, ideally, the main distributors of these doughnuts, although they do use some factories, which we’ll get into later.

Sharma: Yes. We should explain for people who, I guess, that 6% to 7% of people who don’t have the brand awareness of Krispy Kreme, what this term means, Hot Light Theater shops. Is it performance art? Is there someone in the window of a Krispy Kreme eating doughnuts as you drive up? No. It is essentially the theater that goes on when you walk inside a Krispy Kreme. You see the big vats that have the icing. You see these huge conveyor belts which are rolling freshly baked doughnuts down to the glazing process. If you ask often, maybe I shouldn’t be giving this away, but you can ask one of the employees if they’re not too busy to pull one of the doughnuts as it’s coming down the conveyor belt before it gets the icing. See what that tastes like. That’s a favorite pastime in the downtown Raleigh store here where I live, which is one of the first Krispy Kreme locations and still retained its iconic signage. Management has a sense that the making of the doughnuts is theater. They have glass walls at most of their locations. Now some customers can see the doughnuts being made.

But beyond that immediate bit of theater, you see a bigger facility, and that’s the idea that they are trying to bring back. It’s almost like a back-to-the-future move on the part of JAB because originally, this was a model the company thought they could do successfully. Have the theater in front, have the average location actually be much bigger in the back. If you happen to live near Krispy Kreme, drive around the back, you’ll see their delivery trucks. They want to use these as small manufacturing facilities, as Emily points out, then to get the product into the grocery stores and convenience stores. But I think something that you’ve got a problem with — and I do, too, Emily — is that decision has de-emphasized the visibility in some ways of the Krispy Kreme brand? They’ve stopped trying to put locations in highly visible areas just for the sake of having a smaller doughnut shop. Even though that’s the direction that I think Starbucks and Dunkin Donuts, primary competitors for one side of the business, they’ve embarked on visibility and smaller footprints in a big way. It also means that they’ve got to be very, very efficient in each location to make sure that they have a cost-effective supply chain for their so-called hub and spoke network. The spokes being all the grocery stores that they are delivering to.

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We’ll see over the long term if this decision really works out. Now, I will say that management loves the model. They think that it emphasizes the scarcity principle. They say that by really drawing back on the number of big outlets and only making them these Hot Light Theater shops, that adds to the scarcity of finding Krispy Kreme doughnuts. It also brings this great experience for local customers while making sure they’ve got enough capacity to serve grocery stores. I will say that at least in the Mid-Atlantic region, where grocery stores are fighting out for market share, Emily, where you live and also one state South where I live, our corridor is a big battleground for all types of grocery stores. I’ve said this before on our podcast, but think of Publix coming from the South, think of Wegmans coming from the North, the German grocers Aldi and Lidl coming from overseas. Whole Foods trying to establish its presence, Sprouts trying to take Whole Foods’ market share. There are any number of chains like I could go on that are our customers for these Hot Light Theater shops. So there is some sense of this business model in certain geographical areas. Now, to your point: Does it really make sense as a long-term strategy? I think we can get into that more as we go along. I’m a little skeptical though.

Flippen: I will say, I think one of the things the Hot Light Theater shops have done well is advertising that classic Krispy Kreme glazed doughnut, seeing the glazing happening. I think one of the things that shocked me the most was that 64% of Krispy Kreme’s doughnut sales are their original glazed doughnuts. It’s immediately what your mind and your mouth wants when you think about Krispy Kreme. But to your point, that strategy, it’s almost like two separate strategies in my mind because management says that, this is a direct quote, “Their belief is that almost all customers desire an occasional indulgence and that when they indulge, they want a high-quality, emotionally differentiated experience.” I can see how walking into a theater shop and getting yourself a Krispy Kreme, original glazed doughnut, is that really cool, differentiated experience. But on the flip side, when I walk into a convenience store, when I walk into a grocery store and I see those sitting out on a shelf somewhere, even if they’ve been delivered that day, that almost says to me, oh, it’s a spontaneous semi-regular purchase that somebody’s going to make when they walk into their grocery store as opposed to this occasional indulgence. Maybe I’m the only person that feels that way, but in my mind there are just two things that don’t exactly line up.

Sharma: I think you’re on to something. The doughnut that you get in the convenience store, grocery store is a different doughnut than the one you eat in Krispy Kreme. That doughnut that you’re eating in Krispy Kreme hot off the conveyor belt is that experiential doughnut, it is that treat that you are allowing yourself to have. I want to point out for those of you who are really enthusiastic about the consumer goods world, you already know that the indulgent category exists across a continuum. It is healthy and indulgent. There’s permissible indulgence where you’re permitting yourself to do something. There’s core indulgence, you really don’t think twice about it and that’s your main type of indulgent experience. There is the word, I think Emily just used, “treat.” When you’re in treat mode, you’re like, “Get out of my way. I’m going to buy that ice cream, or I’m going to have my doughnut.” To me, the hot doughnut in the stores exists in the treat part of the continuum. If that’s the case, I wonder then about the quality of the doughnuts that you get from the store. They’re not the same. But I don’t like packaged Krispy Kreme doughnuts. I’d much rather have a Dunkin Donut. I think their glazed doughnuts taste much fresher when they’re packaged.

Flippen: Those are fighting words.

Sharma: They’re fighting words. I should say, Dunkin Donuts doesn’t do a lot of packaging, but let’s put it this way: If you take home a dozen doughnuts from Dunkin, and a dozen doughnuts from Krispy Kreme, those of you in the South, you probably know what I’m about to say. The next morning, what are you going to do? You’ll eat that Dunkin doughnut straight out of the box, but you’ll pop that Krispy Kreme doughnut in the microwave for 10 seconds and oftentimes eat it with a fork and knife. If I’m saying something that’s heretical here, let us know for those of you who are watching live today and not listening to it on the podcast. In the comments, we’ll chat about this. But here’s my point: Over the decades, Krispy Kreme has never had a huge penetration on grocery store shelves. So there’s got to be a reason that they’ve not been able to have more penetration than just end caps on aisles and freestanding kiosks in grocery stores. I think the reason is because they are two different experiences — the package doughnut just doesn’t taste as good. It becomes a volume game for them. Krispy Kreme then probably needs to have, rather than a lot more shelf spacing in each store, just get into more stores.

As the grocery industry has been growing at an interesting clip in the past years, maybe that worked as the volume business. I’m with you, though, Emily, I don’t really see the big advantage in the model to going with the hub and spoke strategy. I almost think it would be better for Krispy Kreme to just plow into the same type of road visibility strategy made with double drive-throughs that Starbucks has done successfully or those smaller-footprint stores. I think that wouldn’t harm the brand, and would give them access to additional incremental, profitable revenue. But we can chat about that a little bit more when we get into the financials of this company.

Flippen: It’s something that I find myself really conflicted about, because I have long been a believer that Dunkin Donuts and Krispy Kreme are fundamentally different businesses in terms of who they’re targeting as a consumer. I’ve said this before, but I think the person who goes to Dunkin Donuts is going because they’re going to get a coffee, and then they happen to just grab a doughnut when they’re there because they see them on the shelves. I think the people who’s going to Krispy Kreme are going because they want a doughnut, and they just happen to grab a coffee if they’re there. In some part of my mind, I think the smaller-format stores that are more focused on those people that are just coming in to grab a coffee and maybe grab a doughnut almost serves Dunkin better than it serves Krispy Kreme. But the numbers, I think, paint a different story. In fact, in 2020, 64% of their doughnut sales were done through a drive-through lane. Sure, you could say that’s the pandemic, but that was nearly 50% in 2019. So clearly, consumers are looking for convenience and ease of access for their daily doughnut. I think I fell on the side of the fence with you, Asit. I wish they were going maybe a bit more small-format, a bit more convenience, a bit more drive-through, because Starbucks, Dunkin, a handful of other businesses have had so much success with that strategy.

Sharma: Yes, and Starbucks and Dunkin had concurrent strategic decisions about the same time that Starbucks doubled down on its drive-throughs, Dunkin decided to slim down its store format. I want to quibble with one thing you said, Emily, which is rare but healthy, because I think we tend to see the consumer goods world alike very much when we’re analyzing companies, but I got to quibble with this: I think that consumers of doughnuts in the Northeast probably go into a Dunkin with a dual objective, to get a cup of coffee and a doughnut. I love what you said about the doughnut leading and the coffee being an afterthought with Krispy Kreme and the opposite for Dunkin Donuts. But I think at least in the Northeast, you go in for the same thing. Now, there is a lot to unpack here. I know we need to move on. I will just say this one last thing to unpack it a little bit further.

The strategy for Krispy Kreme is interesting in that JAB, which I said at the outset of this podcast is extremely coffee focused, it’s interesting to me and curious that Krispy Kreme didn’t invest more in its coffee strategy, or hasn’t over the last several years. They were actually starting just before the JAB acquisition. I have not seen any kind of substantive upgrade in their coffee offering, either in what you get in the store or the marketing of it. Dunkin, on the other hand, invested in espresso, in lots of its locations, in the last couple of years installing espresso machines, et cetera. It’s really curious also that Krispy Kreme wouldn’t take advantage of the fact that so many people will go into a store with an offering of sweets just for coffees, what you’re talking about with Dunkin. They missed that signal, I think, and they are missing this big signal that you mentioned. If 64% of your business is coming from drive-throughs that are attached to these big theater-type shops, isn’t that telling you something? I want to give them the benefit of the doubt on one aspect of their growth, which is to say that there is a nice scaling effect that’s going on. The relationship between the Hot Light Theater shops and what they call DFD, which you explained before. This is the direct food delivery to grocery stores, et cetera.

In 2018, Krispy Kreme had 363 of these Hot Light Theater shops globally, And they had 4,071 doors of distributions. The grocery stores, convenience stores, what we’ve been talking about. That’s about 12 DFDs doors per manufacturing center. To date, they’ve got 376 Hot Light Theater shops, and not a lot of movement there, but they now have 7,371 DFD doors. That’s about 19 doors per store. At least on a volume basis, their strategy is working. Now, how does that affect the financial picture? I would argue that, yes, it’s giving them some more revenue, but their margin profile hasn’t really changed a whole lot in those years. But again, management has chosen this direction we, as potential shareholders, will follow this through the next several quarters and years. Those of us who are interested in perhaps taking a position in this company.

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Flippen: I’m also interested in what you think about its market opportunity because we’ve mainly been talking about just the doughnuts. The Hot Light Theater shop stores as well as their distribution to places like grocery stores. While there are a couple of other lines, they launched a fresh packaged experience for your on-the-shelf stack grocery store, and you have pre-packaged Krispy Kreme labeled treats that launched in mid 2020, so relatively new venture. But the one that I was not expecting, was completely unaware of prior to reading this, was Insomnia Cookies, which is a chain that I’m familiar with because I was extremely jealous. All of my friends who went to college in the United States who had access to Insomnia Cookies, this fresh-cookie delivery chain, which apparently Krispy Kreme owned. I think it’s probably a good thing for their market opportunity, expanding outside of just doughnuts.

Sharma: Who knew, right? I had no idea. I think Insomnia Cookies is such a great business idea. You drive by there if you’re out late at night. They are open and delivering cookies to sleep-deprived college students who are often just wrapping up a fun evening. What a great business model, it’s a digital-first business model. I believe it’s probably a tiny portion of the company’s overall profits and revenue. I didn’t see that Insomnia was broken out separately in the S-1 statement. But management did mention that both sides are learning from each other. The idea of scaling into an omnichannel business is something that Insomnia Cookies is not quite as comfortable with because they were a digital-first business. The idea of accelerating e-commerce investments has never been something that Krispy Kreme has totally embraced. But they mentioned in their S-1 that each side now is taking those learnings. Krispy Kreme is studying Insomnia Cookies, e-commerce, its digital footprint, it’s delivery methodologies. And Insomnia is studying how Krispy Kreme can move across all these different channels with the various iterations of the stores they have. Management says it’s a positive for both businesses. So I like that market opportunity, we don’t know how large it is.

We should also mention that Krispy Kreme does have a very healthy global business, many continents. They’re in Asia, Latin America. On a trip to Japan, I walked into the Krispy Kreme store in Shibuya, a really hot neighborhood in Tokyo, which is fun to go to at all hours of the day or night. It has one of the world’s busiest intersections or pedestrian crossings. I think it might be the busiest pedestrian crossing in the world. And the Krispy Kreme store is not located far from that, a really fun store to visit. They do have market opportunities in front of them. But Emily, you had some reservations. You mentioned when we were prepping for the show that the health food crises that keep popping up make you a little bit nervous, especially because so much of this business is centered in the spectrum from the doughnuts to Insomnia Cookies. What about that reservation? Because I’ve got a similar reservation that I want to talk about, but I’m curious to hear your perspective on this one.

Flippen: Yeah, it’s almost twofold because on one end of the spectrum, I think we see a move toward more health foods. It’s not necessarily things that are healthier. It’s the perception of things that are healthier. I don’t think you’re ever going to change the awareness in people’s minds that Krispy Kreme is not a health food. They’re not going to suddenly change their batter to be whole wheat and people are going to say, oh, now I’m going to indulge in Krispy Kreme doughnuts. I think they lose some optionality there. But I also think that when people do make that choice to indulge — have that treat like we talked about earlier — they’re going for a differentiated experience, and maybe I’m showing a little bit of my Texas here and my awareness of what happens in Austin and then quickly spreads to the rest of Texas and the rest of the United States. But we talked about these local brands, these mom-and-pop shops that are really doing a lot to convince people to indulge in specialty treats that are not global brands. I think Voodoo Doughnuts probably comes to mind, and the way that they’ve tackled the Austin market. I don’t think there’s any way that Krispy Kreme moves into Austin and is half as successful on a market that has so many local mom-and-pop doughnut shops the way that they do in, say, North Carolina where they have a really strong base. So I’m a little bit nervous just about how fatty sometimes these trends can be.

When management talked about the market opportunity and the S-1, they highlighted that indulgence foods have historically grown around 4%, but that’s only during peak times, which was actually devastatingly enough. Times of upgrade economic distress and recessions. It makes me wonder about when times are good, maybe people really just aren’t getting their Krispy Kremes the way they were. They were losing a lot of money in the stock market.

Sharma: I can see that even when times are bad, you definitely go to your comfort food. I share in your indulgence reservations, I’ll call them. We’ve seen something similar in the coffee world. Starbucks has had a little bit of headwind as of late, at least before COVID in the number of really great boutique coffee shops that have popped up in so many midsized cities. They were already there in the bigger cities. Surely, Krispy Kreme faces competition from this proliferation of various styles of indulgent treats that are popping up. I think the little muffin shops are one of those iterations. But, boy, we seem to have so many different  where I live, of different flavors, be it fancy cakes, ice cream shops, et cetera. There’s that, but there is something else, too, that gives me a little bit of pause about the market opportunity. This has something to do with the company’s historical growth. I do want to say I love the discipline that JAB brought to Krispy Kreme. They trimmed back the franchise groups. They helped with their deep store retail experience to push the products a little further by only a little into grocery shelves. But you know, even so, this is still a business that takes a lot of capital for Krispy Kreme to break into bigger cities. The obvious examples is the Northeast where Dunkin dominates, but even go to what’s not really considered Northeast as much as a city like Boston. But let’s take a look at New York.

Krispy Kreme has invested a lot of money in a flagship store that was slated to open before COVID had been delayed, finally opening a few months ago in Times Square, a really big, beautiful store. As far as I can trace from the financials, Emily, I think that they put about $10 million worth of store-opening expenses on their books for the store. That doesn’t count the capital expenditure that went into this flagship store. They’re doing this because they’ve got to increase that brand presence and really shake up these markets to pump that brand perception even higher so then they can move into suburbs of major cities. Now management will tell you that there’s a huge market opportunity. Here’s a direct quote from the S-1: “Despite our high brand awareness, we have a limited presence in certain key U.S. markets, such as New York and Chicago, and have yet to build a significant presence in key U.S. cities, including Boston and Minneapolis.” I’m thinking along the lines of your point on indulgence, that regional preferences may be playing a role here. Traditionally in the South, where Krispy Kreme has had its greatest growth in past decades, consumers are always more willing to indulge in treats without thinking about the health consequences as bad as that sounds, versus their Northeastern and Midwestern counterparts. So is there a bit of a ceiling on Krispy Kreme’s growth? Is there a reason that they haven’t been able to penetrate into these major cities? Is that white space there? Because they keep bumping up against the reality that there are entrenched players already in place, and the statistical part of the equation, the population, the demographics, aren’t really going to be super-regular patrons of Krispy Kreme restaurants.

Flippen: I can see that argument. But the flip side of that coin, and I only lived in Connecticut for about a year, but I saw the loyalty that I think the Northeast has toward Dunkin Donuts, which has its own issues in Krispy Kreme penetrating that. But I will tell you one thing, if Dunkin can be so successful in that area of the world, and they put so much better milk, cream, and sugar into their coffees, I think that it’s smart for Krispy Kreme to try. Now, New York, Chicago, that’s different from Boston. I think if they were building out this $10 million store in Boston, I’d feel differently. But I do appreciate the fact that they are trying to build and expand a little bit more through their storefronts especially. I’ll be super interested to see if that flagship store in New York City does anything for them.

Sharma: I’m planning to visit New York at some time in the near future. I will definitely stop by there unless there’s just a huge long line. Luckily for them, even with COVID, I’m pretty sure from a news article I read that they had their traditional long lines when they first opened.

Flippen: Let’s talk a little bit about their financials. The only thing that really stood out to me was that this IPO is wonderfully timed in the sense that Krispy Kreme is going to be able to use the proceeds from this IPO to primarily pay down their debt of which Krispy Kreme has over $1.2 billion of prior to this offering. Once that debt is paid down, this should actually be a profitable business. Their interest expense right now is killing them in terms of the debt load. Paying down some of that debt turns us into a somewhat profitable business. I didn’t get super excited looking at the margins because it’s doughnuts. What are you going to do?

Sharma: That’s right. I think you said that so well. There’s only so much pricing power you can get with a doughnut. Even a doughnut with so much brand recognition, you have to work on the cost side of the equation. Absolutely, right. Emily, they’re knocking out a really high interest portion of their debt picture, which is some related party debt, and they are using another bit of the IPO proceeds to pay down a bit of a term loan. They’ll be left with something like a rough number here, $670 million worth of debt, but that at a lower interest rate based on LIBOR, the London Interbank Offering Rate, versus what they were paying to their related party, which is higher interest. So this will give them some room to breathe on their income statement. Just a couple of things, too. I don’t want to dwell too much on the financials except to say that the business has been set up to generate manufacturing out of these hot theater shops, but also as a supply chain proposition. Krispy Kreme has, I think, about 36 doughnut factories. They actually ship out the stores from these locations which aren’t consumer facing. The model is interesting because they never seem to be at a working capital surplus. That means that they’re always at a deficit, meaning they’ve got more in payables to their own suppliers than they do ready money in the bank. Part of this deficit that they seem to run perennially at has been solved by what’s called a structured payables arrangement.

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What this means is that the company has payables that it owes to its vendors but it works with financial institutions, which give those same vendors a choice to sell their receivables to the financial institution. Bottom-line is at Krispy Kreme then gets a lot more time to pay versus a usual 30- or 60- or 90-day terms with its suppliers, it ends up paying the bank in increments of around 180 days. Of course, there’s a financial cost to that. I believe that, if I remember correctly from my experience with GAAP, generally accepted accounting principles, when you get into the way this hits the income statement, you actually come very close to having to call this debt. And in some cases, structured payables are almost equivalent to debt because you have financing costs and something that’s taking you a long time to pay almost like a note that you have to repay. I’m just going into this bit of detail to say that look, if they could have slightly better operating margins then this sort of drag on their working capital would ease up some. So to your point, Emily, the picture here really is about how they can expand profitably. I think it becomes, at the end of the day, the proposition of selling more doughnuts, whether they do it in their hot theater stores, whether they do it on the grocery shelf, that really is the kicker here. You’re talking about at the end of the day, a net margin that might be anywhere from 2% to 4% in a given year. Meaning thereby, they take home about $0.02-$0.04 of profit on every dollar of sales that they’re able to generate. So to do better and then to have the resulting cash flows help the business, they’ve got to either expand those margins or to sell more doughnuts. I’m totally with Emily here. They need to sell more doughnuts. There ain’t a lot more they’re going to get out of the pricing equation there.

Flippen: I’m curious about summing up this business. Long time Fools, long time subscribers to Stock Advisor, one of The Motley Fool services, may be familiar with Krispy Kreme, because I think David Gardner recommended it not too long after it went public in the early 2000 and it was a terrible investment. I think it was eventually sold from the Stock Advisor scorecard before it was later then acquired, and Asit, you and I, alongside a handful of other Fools have now taken over some responsibility for Stock Advisor as David transitioned off. Looking at Krispy Kreme today and thinking about The Motley Fool checkered past with Krispy Kreme, are you interested in this business? Could we see this in the Stock Advisor scorecard one day?

Sharma: Well, Emily, you really put me on the spot, because folks, Emily and I have just started our transition to lead part of Stock Advisor and eventually how Stock Advisor will evolve, we’ll be playing a fund role in it. I will say, but I’ll take your question at face value and just say that the company is really great consumer-facing brands. You can see why it caught David’s attention. He’s picked so many companies that were consumer-facing as has Tom, over the years. We forget about their big whiffs and we love and appreciate their home run. This was just a big whiff, I think that it was harder to see in that S-1 so many years ago, the problems that were in the management chain that all came out later. The company just ended up having all yellow and red flags about its management that bit by bit trickled out. I’m going to shock you by saying that I’m going to watch this business.

I’m skeptical of its growth prospects, I’m skeptical of its financial equation. But as we have been talking about since January, it’s important to pay attention to the brand. I noticed before we went on air, Emily, you’re drinking from a Yeti cup. We’re not going to belabor and bore listeners with our mutual sob stories about missing Yeti as a great investment. A lot of that has to do with its brand power. Krispy Kreme is getting another chance. They’re backed by a very deep-pocketed, structured, disciplined private investment firm that, as we mentioned, is hanging on to 40% of shares and can exercise a lot of control. I wouldn’t count Krispy Kreme out. Now, is just going to hit the scorecard next month? No, it’s going to take some time if it ever happens. But now, let me turn the tables, my friend. Emily, is this something that you might be looking at for a future recommendation for Stock Advisor?

Flippen: You always say things so beautifully and my only answer is just going to be a resounding “Oh, no way!” [laughs] It’s hard for me to get excited about doughnuts, not being a big doughnut connoisseur myself, but it’s a low-margin business, their strategy confuses me, I think they’ve devalued their brand’s name a lot. But everything you’ve just said prior to my negativity was very true. I do think it’s a bit auspicious that I’m sitting here drinking out of a Yeti mug, which I was given as a gift. To be very clear, I did not buy this myself. I would never betray my investing instincts like that. But it was a stock and investment that I missed because I didn’t understand the brand power. Maybe I’m doing the same thing here at Krispy Kreme. I will take out a piece of advice from you Asit: I will watch this one myself. I wasn’t originally very excited about it, but I’m often wrong.

Sharma: Yeah, to that point, Emily, let’s quickly, before we exit, maybe a sentence each talking about the risks we’ve seen and this will help eliminate, I think more why we both are initially skeptical, but we’re going to keep an open mind on this one. It sounds like you are, and I am as well., I would say the probabilities of it being our performer or small, but you never know and that’s the fun of the stock market, the fun of investing. Sometimes, your best investment surprises you and sometimes the companies you think are going to just go out and crush it, they just wither on the vine. Give me one or two risks really quickly that you see in this company going forward.

Flippen: For me, it’s just all consumer preferences. This is a doughnut business, unlike Dunkin, which has a lot of higher-margin coffee products. Krispy Kreme sells 64% a single product: that single glazed doughnut product. That to me is just not in a super exciting place for me to put my money today, so it doesn’t excite me.

Sharma: I will say, for me, I second that and I will say that this approach of doubling down on the hub and spoke concept that while it has its obvious advantages. I just don’t know if that’s the right direction strategically, I’d just reiterate, should they have gone into some type of avenue that replicates Dunkin’s new model or Starbucks’ attention to the drive-through. This is something we’ve missed, not just Starbucks and Dunkin, it’s also McDonald’s, which is the biggest and baddest fast-food or quick-service entity on the planet. They recognized that a long time ago and I’ve never wavered from their focus on efficient stores with a drive-through. At least in North America, it’s road-based culture. You can’t totally leave that behind. But they could prove me wrong. Again, open to changing my mind as the quarters roll by.

Flippen: I’m also open to changing my mind, and I always love having these chats with you, especially when we get the chance to talk about doughnuts for an hour, it’s a treat.

Sharma: I’m so hungry. In contrast to Emily, for those of you who are watching live, you can tell from my cheeks that I actually enjoy a good doughnut or two or three.

Flippen: I much prefer to get my indulgences in things like eating an entire Snickers bar or going through an entire bag of popcorn. So I have my vices. Doughnuts just aren’t one of them.

Sharma: Yay to that.

Flippen: Well, Asit, thank you as always for joining.

Sharma: Thanks so much, Emily. This was so much fun.

Flippen: Listeners, that does it for this episode of Industry Focus. If you have any questions or you just want to say, “Hey,” you can always shoot us an email at or tweet at us at @MFindustryfocus. As always, people on the program may own companies discussed on the show and The Motley Fool may have formal recommendations for or against any stocks mentioned, so don’t buy or sell stocks based solely on what you hear. Thanks to Tim Sparks for his work behind the screen today. For Asit Sharma, I’m Emily Flippen. Thanks for listening and Fool on.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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