Street Patrol
Recent articles:
• Best Buy proves again why it's the best, 6/14/2005
• Intel has enough good news to go around, 6/9/2005
• GM's CEO blew his big chance, 6/7/2005
More...
| | Street Patrol
Exec purge fails to sweeten Krispy Kreme
The doughnut maker showed six high-level executives the door as part of a probe into its accounting practices. But investors still have hope for the stock. They shouldn't.
By Robert Walberg
One key to successful investing is being able to read between the lines. Fortunately, you don't need to be a cryptologist to understand that Tuesday's announcement by Krispy Kreme (KKD, news, msgs) that five executives have resigned and one chose to retire is bad news for the stock. The massive turnover of key employees resulted from a recommendation of a special committee of the company's board of directors.
Given all of the company's past problems, why should investors be disappointed by the fact that several old-time employees, apparently responsible for some of the mess, are leaving? First, this is a company in transition. Sales are slumping horribly, cash flow is dwindling and outstanding obligations are growing. Losing key, experienced management personnel at such a time is never a good thing, especially when the group leaving constitutes almost half of the company's senior executives. The committee, after all, was focusing on legal and ethical matters, not competence.
Even if we assume that the insiders promoted to replace the outgoing executives prove to be competent, the ouster of four senior vice presidents from a wide range of areas (finance, operations, business development and manufacturing and distribution) during a Securities and Exchange Commission investigation into accounting violations suggests that the potential infractions will be more severe and more widespread than many had hoped. It also calls into question the previously stated results. True, we know these numbers will be restated, but the severity of that restatement is now likely to be much worse than originally feared.
Making investors wait
If Tuesday's news wasn't troubling enough, the company also recently announced that it wouldn't file its fiscal first-quarter earnings report on time due to the ongoing investigations into its accounting practices. The company hasn't filed a financial report since September of last year.
However, management did note that sales remain disappointing (down 17%) and that it would post a loss for the quarter. The Street had been expecting earnings of 1 to 2 cents a share. In other words, analysts were disappointed once again as the pace of the company's decline exceeded its already pessimistic assumptions.
The core of Krispy Kreme's problem is the bearish trend in average weekly sales. According to the recently filed document with the SEC, system-wide average weekly sales declined by 21% versus year ago figures in the fiscal first quarter. Two things stand out about this number. First, the decline is considerably worse than Wall Street expected, which was a decline of 12% to 15%. Second, and almost as important, is that the huge declines are coming off of weak comparisons. This isn't a business that's suddenly seeing a sizeable slowdown after significant growth. It's a business in serious decline with no signs of recovery.
To its credit, new management is working quickly to close underperforming stores and sell underperforming assets. But its actions might not come fast enough, especially if in closing stores the company experiences a decline in cash flow, which it can ill afford given mounting debt and lease obligations. Toss in the legal costs and the financial picture is bleak.
Too much hope
Despite these rather obvious problems, the stock has rebounded by more than 36% since bottoming at $5.63 in late April. Optimism surrounding new management and the ability to restructure debt contributed to the rally effort, but this is a turnaround based more on speculation than on any real signs of progress.
As I noted in my Street Patrol article on Krispy Kreme in January, most turnarounds stories never materialize. The companies simply continue to struggle and underperform. That looked to be Krispy Kreme's fate then, and there's been nothing that has happened over the past six months to change my view. To the contrary, the news simply gets uglier by the day.
Almost as stunning as the news is the fact that investors continue to believe in the hype and the hope that once made Krispy Kreme a high-flying stock. The stock recently was trading at 69 times estimated fiscal 2006 earnings of 11 cents a share, a forecast that has been coming down steadily and one that's probably still too optimistic given ongoing sales woes and mounting legal costs. Frankly, that's an insane price to pay for a company with so many questions and so few answers.
At the time of publication, Robert Walberg neither owned nor controlled shares in any equities mentioned in this column.
| |
|
|
|
|
MSN Money's editorial goal is to provide a forum for personal finance and investment ideas. Our articles, columns, message board posts and other features should not be construed as investment advice, nor does their appearance imply an endorsement by Microsoft of any specific security or trading strategy. An investor's best course of action must be based on individual circumstances.
|
