1. What can the historical income statements (case Exhibit 1) and balance sheets (case Exhibit 2) tell you about the financial health and current condition of Krispy Kreme Doughnuts, Inc.?
The historical financial statements can tell us a lot about the financial health and condition about Krispy Kreme or any other company. By utilizing some key financial ratios we can determine how the company compares year over year as well as against competitors in many ?different dimensions. These dimensions include short term solvency, or its ability to meet its immediate obligations, long term solvency, or its ability to manage debt leverage, asset management, or its ability to utilize company assets to make profit, profitability, or its ability to generate a favorable bottom line, and market valuation measurement, or its overall company value in the market compared to book value or earnings.
2. How can financial ratios extend your understanding of financial statements? What questions do the time series of ratios in case Exhibit 7 raise? What questions do the ratios on peer firms in case Exhibits 8 and 9 raise?
As mentioned above financial ratios can really give an analyst a look into how effective, efficient, and profitable a company is and has been in the past.
In exhibit 7, different ratios bring up different questions. The trend of the current ratio is a bit puzzling to me and begs the question, why does it continue to grow? Krispy Kreme has by far the highest current ratio in the industry, and it appears as though some of the biggest competitors have current ratios at or below 1. Although it is good to have short term solvency, too high of a ratio could be a sign of missed opportunities for investment. What else could Krispy Kreme be doing with its liquid assets that might garner increase profitability that seemingly others in the industry are acting on?
The next ratio that interests us is the asset to equity ratio, or the equity multiplier. This ratio is an indicator of how the company manages leverage. The higher the ratio, the more of a percentage of operations is funded by equity. Krispy Kreme’s equity multiplier has been relatively consistent since 2001, but is just below par with most of its competitors. What this means to us is that Krispy Kreme is not as effective in utilizing leverage to benefit the company as some of its competitors which doubles up on the previous question asked. What else should Krispy Kreme be doing, or investing in to improve efficiency and performance.
Total asset turnover is an important ratio to look at because it is an indicator of how well a company utilizes its assets to generate sales. The first thing that we noticed is that Krispy Kreme’s total asset turnover ratio decreased every year from 2000-2004. This speaks to an increase in inefficiency in the use of asset to generate sales. It should however be noted that it is typical that as companies grow, it is difficult to maintain a higher total asset turnover ratio. That notation is exemplified when you look at the competitor ratios. The biggest competitors like McDonalds and Wendy’s have similar if not lower ratios. Our overall concern is that none of the other competitors had ratios that low and we did not feel that Krispy Kreme was or is anywhere near the size of McDonalds or Wendy’s. This raises the concern that even though the company is expanding and acquiring new assets, it is not effective in translating the growth into sales.
Finally, and perhaps most importantly, we took a look at ROE, or return on equity. This ratio gives an idea of the profitability of the company as well as a return that an investor would expect on his or her investment. Although Krispy Kreme has benefited from stable ROE over the period of 2000-2004, it is sub-par compared to its competitors. What would make Krispy Kreme more attractive to investors, if its ROE is below average in its own industry?
To look a little further into some of the statements and ratios, we did a DuPont analysis for Krispy Kreme and several of its competitors. Each of the individual components have been previously discussed, but it is interesting to compare them together to see how three of the most important aspects of the business have changed over time. Specifically it is worth noting that Profit Margin has increased significantly every year since 2000. What this means is that Krispy Kreme has gotten better every year at turning each sale dollar into net income.
3. Is Krispy Kreme financially healthy at year-end 2004??
When looking at the 2004 DuPont analysis, you see that not only has profit margin increased every year, but it is more than 2% better than the industry average. That being said, Krispy Kreme does not utilize its assets as efficiently as its competitors. This potentially troubling because of the fact that they have gone through aggressive growth in stores recently. Is this an indication that these stores are not generating the sales necessary to justify the investment, or at least as well as its competitors might be able to? Finally the equity multiplier comes in below the industry average. To us this means that Krispy Kreme does not utilize its leverage as effectively as the competition. Perhaps it would be to Krispy Kreme’s benefit to increase leverage and invest in order to increase growth and earnings in a similar manner to its competition. Overall, we believe that Krispy Kreme is moderately financially healthy as of the year end 2004. The profitability of the company is well above industry average, and the asset turnover and equity multiplier ratios are not drastically different from industry averages.
4. In light of your answer to question 3, what accounts for the firm’s recent share price decline?
There was a decline in the share price because, firstly, the company said to expect fewer earnings because of the low-carbohydrate diet trend and also they had close down few underperforming shops, which was a result of their aggressive store expansion. The main cause of the recent share price decline is when the financial scandals became public. As a result, investors lost confidence in the company.
5. What is the source of intrinsic investment value in this company? Does this source appear on the financial statements?