Three Reasons Why DNUT is Risky and One Stock to Buy Instead

November 29, 2024 at 04:34 AM EST

DNUT Cover Image

Although Krispy Kreme (currently trading at $10.99 per share) has gained 8.6% over the last six months, it has trailed the S&P 500’s 14.2% return during that period. This was partly driven by its softer quarterly results and might have investors contemplating their next move.

Is there a buying opportunity in Krispy Kreme, or does it present a risk to your portfolio? See what our analysts have to say in our full research report, it’s free.

We don't have much confidence in Krispy Kreme. Here are three reasons why we avoid DNUT and a stock we'd rather own.

Why Is Krispy Kreme Not Exciting?

Famous for its Original Glazed doughnuts and parent company of Insomnia Cookies, Krispy Kreme (NASDAQ: DNUT) is one of the most beloved and well-known fast-food chains in the world.

1. Revenue Projections Show Stormy Skies Ahead

Forecasted revenues by Wall Street analysts signal a company’s potential. Predictions may not always be accurate, but accelerating growth typically boosts valuation multiples and stock prices while slowing growth does the opposite.

Over the next 12 months, sell-side analysts expect Krispy Kreme’s revenue to drop by 2.8%, marking another decrease from its 12.7% annualized growth for the past five years. This projection doesn't excite us and implies its offerings will face some demand challenges.

2. Cash Burn Ignites Concerns

Free cash flow isn't a prominently featured metric in company financials and earnings releases, but we think it's telling because it accounts for all operating and capital expenses, making it tough to manipulate. Cash is king.

Over the last two years, Krispy Kreme’s capital-intensive business model and large investments in new physical locations have drained its resources, putting it in a pinch and limiting its ability to return capital to investors. Its free cash flow margin averaged negative 3.3%, meaning it lit $3.33 of cash on fire for every $100 in revenue.

Krispy Kreme Trailing 12-Month Free Cash Flow Margin

3. Short Runway Exposes Shareholders to Potential Dilution

As long-term investors, the risk we care about most is the permanent loss of capital, which can happen when a company goes bankrupt or raises money from a disadvantaged position. This is separate from short-term stock price volatility, something we are much less bothered by.

Krispy Kreme burned through $99.4 million of cash over the last year, and its $1.30 billion of debt exceeds the $25.88 million of cash on its balance sheet. This is a deal breaker for us because indebted loss-making companies spell trouble.

Unless the Krispy Kreme’s fundamentals change quickly, it might find itself in a position where it must raise capital from investors to continue operating. Whether that would be favorable is unclear because dilution is a headwind for shareholder returns.

We remain cautious of Krispy Kreme until it generates consistent free cash flow or any of its announced financing plans materialize on its balance sheet.

Final Judgment

Krispy Kreme isn’t a terrible business, but it isn’t one of our picks. With its shares lagging the market recently, the stock trades at 38.8x forward price-to-earnings (or $10.99 per share). This valuation tells us it’s a bit of a market darling with a lot of good news priced in - we think there are better investment opportunities out there. Let us point you toward TransDigm, a dominant Aerospace business that has perfected its M&A strategy.

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