Krispy Kream

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Krispy Kreme Doughnuts
Teaching Note

Background

Krispy Kreme (KKD) has achieved spectacular growth in the last few years using an area developer model to expand geographically. This case examines the factors that have driven its growth and their sustainability in the coming two years. Students are provided with forecasts made by financial analysts at CIBC. They are then asked to identify and evaluate the assumptions underlying these earnings forecasts. Since the CIBC report does not provide a forecasted balance sheet for KKD, the case can be used to let students learn how to build a forecasted balance sheet. Finally, the case can be used to discuss potential conflicts of interest between analysts and investors that might lead analysts to over-sell a growth firm such as KKD.

Questions:

1. Analysts are predicting that Krispy Kreme will be able to perform highly effectively and continue to grow rapidly in the coming two years. Do you agree with their analysis? If so, why? If not, why not? 2. What factors did the CIBC analysts examine to forecast sales growth for KKD in the years ended January 2003 and 2004? What assumptions did they implicitly make about number of new stores and weekly sales per store (for both company and franchise stores)? What are their implicit assumptions about revenue growth from franchise operations and KKM&D? Do you agree with these forecasts? 3. What are the NOPAT margins that the CIBC analysts have forecasted for KKD for the years ended January 2003 and 2004? What assumptions were made about specific expense items (e.g. margins, G&A, D&A, taxes)? Do you agree with these forecasts? 4. The CIBC analysts do not forecast KKD’s balance sheet for the following year (ended January 2003). Make your own balance sheet forecasts. 5. In general, do you expect analysts’ forecasts for a company like KKD to be optimistic, pessimistic or unbiased? Why?

Question 1: Analysts are predicting that Krispy Kreme will be able to perform highly effectively and continue to grow rapidly in the coming two years. Do you agree with their analysis? If so, why? If not, why not?

Key factors underlying growth:

1. Brand based on high quality product.

2. Fragmented (regional) competition with less brand recognition

3. Strong opportunities to extend network of stores geographically.

4. Area developer model seems to be working. Company store data suggests that model probably works for area developers. eg.

Revenues ($70 per week *52)$3,640
Gross profit at company rate (18%)655
Royalties (5.5%)(200)
Mark up on KKM&D (8.2*royalties*17%) (280)[1]
Capital charge (10%*$1.4m cost of a store) (140)

Net 35

Further, if area developer models go broke, KKD seems to be able to operate them profitably.

5. Small store growth with new technology, and international growth hold promise, although untested. Beginning to compete with Starbucks. Will donuts appeal to non-US market?.

Potential Concerns

1. Is this a fad? Will consumers tire of donut craze? But donuts have been popular for many years.

2. Competition likely in long-term.

Question 2: What factors did the CIBC analysts examine to forecast sales growth for KKD in the years ended January 2003 and 2004? What assumptions did they implicitly make about number of new stores and weekly sales per store (for both company and franchise stores)? What are their implicit assumptions about revenue growth from franchise operations and KKM&D? Do you agree with these forecasts?

Revenue Forecasts

The CIBC analysts’ forecasts were constructed using per store information.

• Company plans to add 62 new stores in 2003, mostly through area developers.

• What are revenues per new store? Initial boom, followed by leveling off. Also, not all new stores are open for full year.

• Revenue growth per new store has...
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