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JBL: Global Gluttony

John Layfield

There is an over 33% obesity rate in the U.S. and a lot of people who eat very poorly. Krispy Kreme (KKD Quote) was quick to give these people -- everybody, in fact -- a tasty treat, and is now targeting the very same market abroad. Fortunately for Krispy Kreme, there are doughnut-loving people all over the world.

Krispy Kreme was the darling of Wall Street earlier this decade, but expanded recklessly, and prior management used accounting later deemed egregious by a special board committee. Because the company is restating its results back to before its 2000 IPO, Krispy Kreme hasn't reported earnings since 2004 and won't do so until the end of April.

Krispy Kreme has closed more than 80 stores nationwide since turnaround specialist Stephen Cooper came on board last year. Krispy Kreme has also been replacing management that was accused of "creative" earnings, including longtime CEO Scott Livengood.

Fundamentally, the company also missed a key ingredient to success: it could never make a good cup of coffee. Dunkin' Donuts makes up to 50% of its revenue from coffee; Krispy Kreme makes only around 10%. Add up all of this bad news and you have a Shakespearean tragedy in which everyone comes up a loser.

This was until this week, however, when Krispy Kreme was flying high again. The stock jumped over 20% Tuesday on the news Daryl Brewster, former head of Kraft's North American operations, has been named the new CEO. Cooper will stay on as chief restructuring officer.

Overshadowed by the excitement over Brewster is something crucial that few are factoring into this stock: Krispy Kreme is a real growth story overseas. In one article I read, the writer scoffed at the idea that it planned on foreign growth, because the writer thought Krispy Kreme should spend its energy on domestic issues. Wrong.

To watch JBL's video take of this column, click here.

Krispy Kreme already has a presence overseas and is doing well. In the U.K., Krispy Kreme opened up its first store in Harrods and has now expanded all over London and beyond. Krispy Kreme did what Dunkin' Donuts couldn't do -- convince the British to eat doughnuts.

In Australia, Krispy Kreme started in Sydney and now has plans to open stores across the country. While not as well received as in London due to local chain Donut King's lower prices, Krispy Kreme has great opportunities in the land Down Under.

I cannot recommend buying a stock where you have absolutely no way of practicing standard due diligence. However, once earnings are released, I want you to be in front of the herd. The growth story overseas will most likely not be told with the release. A good management team has an opportunity to learn from past mistakes and not replicate them overseas. Krispy Kreme could be the turnaround play of the year; we could be in the third inning of an incredible story.

While I can't recommend buying Krispy Kreme right now, one stock I do suggest you buy is Valero Energy (VLO Quote).

Refining Opportunity

With lack of refining capacity comes the ability to raise prices. New Valero CEO Bill Klesse said at a recent energy conference in San Antonio that the prospect of a new refinery in the U.S. was zero. Obviously, this gives Valero, which provides the U.S. with 12.8% of its refined crude, a huge advantage.

Klesse said that 2006 would be a record year for profits, just like 2005. I understand that crude inventories are the highest they have been since 1999 due to a warm winter. However, I believe oil will stay high due to geopolitics, and the one part of the oil chain that has no capacity is refineries. Plans by Saudi Arabia to build refining capacity will not affect the market in the short term. Long term, it will provide options, but the expense to ship refined crude from the Persian Gulf to the U.S. will offset any damage additional capacity might levy on Valero.

Refineries, just like the land drillers I recommended two weeks ago, trade in line with oil prices. No matter the price of oil, there is simply no additional refining capacity and none coming online.

Last year was a record one for Valero, with an 87% increase in EPS. Seventy percent of Valero's oil is sour crude, which is purchased at a price less than sweet crude. The spread between sour crude oil and sweet crude oil increased 30% in 2005. This helped Valero post net income of $3.6 billion, which was double the previous year's $1.8 billion.

Valero's return on equity is more than 31% and its forward P/E multiple just 7.6, meaning the stock remains cheap. Furthermore, as I write every time I mention energy stocks: Nothing has changed since last year in terms of supply and demand; we are just starting the year with higher oil prices. Until supply and demand are addressed, what worked last year will work continue to work.

While margins most likely will not stay this high throughout the year, Valero will continue to make record profits.

Finally, shares of both Patterson-UTI Energy and Bronco Drilling have dropped since I recommended them two weeks ago. I still own both stocks and am looking to buy more shares. Both land drillers have increasing rig utilization regardless of whether oil prices have been up or down. I believe both are bargains here.

Remember, being poor is bad; staying that way is stupid.