Bear of the Day: Krispy Kreme (DNUT)

Krispy Kreme (DNUT), the iconic doughnut chain, has been a major disappointment since returning to the public markets in 2021. Shares have lost the vast majority of their value as weak unit economics, slowing US growth and an increasingly burdensome debt load overwhelmed what initially looked like an attractive expansion story.

The failed McDonald’s rollout only added to those problems. Krispy Kreme had hoped its hub-and-spoke distribution network could dramatically expand product availability, but the strategy proved costly to operate and many delivery locations failed to generate sufficient returns. At the same time, elevated interest expense and years of negative earnings left the company with very little financial flexibility.

There are finally some signs of improvement. Krispy Kreme’s turnaround plan is focused on refranchising international markets, reducing debt and concentrating investment on its most profitable opportunities. First-quarter adjusted EBITDA increased 38%, free cash flow turned positive and net leverage fell to 5.5x from 6.7x the previous quarter.

Unfortunately, Wall Street is not yet convinced the turnaround will translate into sustainable earnings growth yet. Analysts have continued to cut estimates, while revenues are expected to contract this year and again next year, earning DNUT a Zacks Rank #5 (Strong Sell).

It pains me somewhat to make Krispy Kreme the Bear of the Day, I remain a huge fan of the product, but the stock and the doughnuts are two very different things. There may ultimately be an attractive recovery story here, especially if deleveraging continues, but it is difficult to get constructive until earnings estimates finally begin trending higher.

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Analysts Downgrade DNUT Stock

Earnings estimates for Krispy Kreme have been trending lower for several years, and that negative revision cycle remains intact. Over the recent period, the consensus estimate for next quarter has fallen 14.9%, while next year’s estimate has been cut by 43%. The current-year outlook was revised slightly higher, but only from a loss of $0.07 per share to a loss of $0.06.

Krispy Kreme did manage to beat expectations in its latest quarterly report, but those estimates were already set at depressed levels. More importantly, the broader growth outlook remains weak. Sales are currently projected to decline 13.1% this year and another 9% next year.

Until those revenue trends stabilize and analysts begin raising earnings expectations more meaningfully, it is difficult to make a convincing case that DNUT’s fundamental turnaround has taken hold.

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Should Investors Avoid DNUT Stock?

For now, I think the answer is yes. Krispy Kreme is making progress on debt reduction and cash flow, but the operating outlook remains too weak to overlook. Revenue is still expected to contract, earnings estimates continue to move lower and leverage remains elevated.

That does not mean the turnaround cannot eventually work. If sales stabilize, deleveraging continues and estimate revisions finally turn positive, DNUT could become an interesting recovery story. Until then, however, there is not enough fundamental evidence to justify stepping in front of the negative earnings trend.

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This article originally published on Zacks Investment Research (zacks.com).

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