I have been an admirer of the Krispy Kreme Doughnut ever since they opened a store about 30 minutes from my home and I drove out to try an original glazed hot from the fryer. Krispy Kreme (KKD) went public several years ago to much fanfare and looked to be invincible as it began its breakneck paced expansion across the US. Unfortunately KKD suffered from expanding too fast and has hit speedbumps along the way and now is an unprofitable, disorganized company now only trading at 3.25/share and a market cap of just barely $200 Million.

I have become increasingly bullish on Krispy Kreme after its bad earnings announcement and subsequent 50% drop in share price as investors overeacted to a very large one-time lease termination charge of about $20 Million. These charges will most likely continue as KKD closes more company locations, but not on the same scale. There is no doubt that the turnaround being led by company CEO Daryl Brewster is not moving along at the pace that everyone expected.

The reason I have become so interested in this stock and begun accumulating at anything below $3.50/share is that I noticed a trend at the Wal-Mart’s in my area… they are now, as of a week ago, carrying large Krispy Kreme Doughnut displays. I remember when KKD experimented with operating a full scale store inside of a Wal-Mart and the idea flopped, however a potential move to retail the company’s doughnuts in over 2,000 Supercenters across America could be a very profitable venture for both companies.

As a former Wal-Mart employee I can attest to the poor quality doughnuts being offered in the company’s bakeries. The doughnuts come in frozen and precooked, they are then thawed, iced, and put in the display. I, for one, think they are disgusting and bringing in Krispy Kreme could increase Wal-Mart’s bakery sales if they are marketed properly inside the store. At the Holland, Michigan Wal-Mart Supercenter for instance, the display is being shoved around the store in a very unintelligent manner, moving from the bakery to the General Merchandise side of the store and everywhere in between, while a pharmacy display sits by the milk in the dairy department for the last two years (don’t even get me started on that). Every other grocer I have seen a Krispy Kreme display in, puts the doughnuts right in front of the milk coolers, perhaps Wal-Mart here in Holland will smarten up and get with what retailing is all about.

Now back to the investment. KKD is trading at an all-time low currently and is a potential candidate for even worse fortunes, but I don’t believe that will happen. KKD could potentially be transforming their brand in order to save the company, by shifting to a retailing operation rather than a restaurant operation. The retailing of the boxed doughnuts does not increase KKD’s operating costs in any significant way because the doughnuts are being manufactured in an existing facility within close proximity to the retailer they are displayed in. This is a terrific opportunity to spread the brand into an ever increasing geographic area and at the same time, generate low cost new sales of the product without cannibalizing the sales of existing Krispy Kreme restaurants.

The other thing to keep in mind is that KKD has not announced anything beyond they are experimenting with trans fat free oils. In order for them to continue doing business in New York City and Philadelphia they must not sell any food with trans fats. So an announcement will becoming before the summer of 2008 or they would have to close their stores located there and I don’t think they will let that happen. Any announcement of eliminating trans fats in its doughnuts will surely cause a boost in sales and share price as the public give themselves “permission” to eat a Krispy Kreme doughnut because it’s “healthier”, when in fact it will still contain just as many calories. But the food industry is increasingly promoting no trans fat products as healthier and the consumer is believing it.

I’d like to see KKD rise into the double digits again within the next twelve months as the turnaround continues and is ultimately successful. Currently, at $3.25/share, moving to 13 would mean a 400% return.