The Atkins Excuse

The low-carb, high-fat way for an executive to duck blame.

Krispy Kremes
“Keep your eye upon the doughnut …”

The Atkins diet has proved a threat to companies that peddle carbohydrates—everyone from McDonald’s to Anheuser-Busch is quivering about the low-carb craze. Many have responded by altering menus or introducing low-carb versions of beer and pizza. And now Atkins has also become a convenient excuse for businesses that are stumbling for other reasons.

Exhibit one: the world’s greatest doughnut. Last Friday, Krispy Kreme blamed its lowered earnings guidance on a sudden uptick in Atkins interest among fried-dough consumers. Chief Executive Officer Scott Livengood noted that last year, Atkins had “little discernible effect on our business.” But we’ve apparently reached something of a noshing point. In the first part of 2004, the volume of U.S.-packaged doughnuts fell 0.4 percent percent from the year before. And Krispy Kreme Chief Operating Officer John Tate told the Wall Street Journal that the number of people filing into Krispy Kreme stores has fallen “for the first time in recent memory.”

Krispy Kreme’s stock slumped 29 percent last Friday, marking the end of the booster stage for one of the darlings of the recent bull market. Krispy Kreme became a hot-fat phenomenon over the past decade, as the chain spread rapidly from its Southern base. All over the country, eager chowhounds wolfed down warm glazed doughnuts as they chugged off conveyor belts. Investors, ravaged by tech-induced indigestion and eager for comfort food, also flocked to Krispy Kreme’s stock. After it went public in April 2000, at a split-adjusted $5.25, Krispy Kreme enjoyed a near-parabolic rise into the 40s. In June 2003, Krispy Kreme got the full Fortune treatment from Andy Serwer—3,633 words of fulsome praise. (Sample gushing quote from board member Erskine Bowles: “But I’ve got to tell you, I’ve never seen another company like it.”) At the time, Krispy Kreme traded at a high 32 times its projected 2004 earnings.

But one could make the case that Krispy Kreme’s fall—the stock is off by about 50 percent since last summer—has little to do with the diet. Part of the stock decline is simple retrenching after Krispy Kreme’s excessive rise. After all, despite the scaled-back earnings forecast, Krispy Kreme’s sales are still growing at a healthy 25 percent clip, thanks to new store openings, higher prices, and a push into other retail channels. The stock has dropped hard because it was so absurdly overvalued, not because Krispy Kreme is in Atkins freefall. The stock still trades at a premium to the market; it’s just that the premium isn’t as big as it was a few months ago.

Nor is Atkins responsible for the company’s clumsy growth strategy. Over time, Krispy Kreme has come to rely less on sales of fresh donuts at Krispy Kreme stores and more on sales of somewhat less fresh donuts in convenience or grocery stores. And as any connoisseur will tell you, there’s simply no comparison between the two. The Wall Street Journal noted that “off-premise sales have slowed.”

Krispy Kreme has also diversified poorly. In 2003, it bought Montana Mills Bread Co., a Panera Bread wannabe whose outlets are concentrated in the slow-growth desert of upstate New York. Now Krispy Kreme is taking a big charge to unload Montana Mills. Is that Atkins’ fault, too? Not necessarily. The stock of competitor Panera still sells for a lofty 38 times earnings. Montana Mills simply wasn’t as good a business.

The Atkins excuse is also being made in the pasta business. According to AC Nielsen, the volume of retail dry-pasta consumption fell 7 percent in the 13 weeks ended March 20, 2004. Yesterday, New World Pasta blamed this Atkins-induced slump for its bankruptcy filing. (Privately held New World is controlled by JLL Partners and makes brands such as Ronzoni.) But a look at its Securities and Exchange Commission filings shows that low-carb dieters aren’t its real problem. New World had the classic recipe for a failed leveraged buyout. The company had operating losses in both 2002 ($40 million) and 2003 ($30 million). Because it was highly leveraged, it ran through cash rapidly. In both 1999 and 2000, interest payments of $26.2 million and $28.9 million, respectively, obliterated its profits. In the fall of 2002, as the Wall Street Journal reported Monday, the company disclosed that computer system glitches “had rendered ‘unreliable’ its financial statements since early 2001.” A new CEO was brought in last May.

A slump in sales by a few percentage points—which is all that Atkins has caused—shouldn’t make the difference between survival and failure, unless you’re in trouble to begin with. Indeed, American Italian Pasta Company, a publicly held company, is similarly dependent on sales of noodles. But as its most recent earnings report shows, the company, which has little debt, is doing quite nicely.

The question for investors in Krispy Kreme—and in other companies who have staked their future on high-carb products—is whether Atkins exerts a lasting influence on consumption patterns. I’m guessing it won’t. After all, for all the time and money we spend on diets and diet products, we Americans are getting fatter every year. As you’re lying on your couch shoveling snacks into your mouth, you should have plenty of time to think about the companies you want to invest in. Remember: Don’t worry about the fads, worry about the financials.