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Here's BofA View of McDonald's-Krispy Kreme Tie-Up

The two companies have partnered so far to provide three flavors of Krispy Kreme donuts at nine McDonald's restaurants.
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What do you get when you mix McDonald’s  (MCD) - Get Free Report with Krispy Kreme  (DNUT) - Get Free Report

Well, regardless of the effect on customer waistlines, the new link-up between the companies could help the business fortunes of both, Bank of America analysts say.

“MCD and DNUT have partnered to provide a limited run of three of Krispy Kreme's most popular flavored donuts at nine [McDonald's] restaurants in Louisville, Ky, available all day for individual or six-pack orders through in-restaurant and drive-through orders,” the analysts wrote in a commentary.

“While a successful run of the test, and subsequent broader rollout, could boost MCD's sales, the impact would be more material for DNUT. MCD has 13,400 domestic units, more than twice as many as DNUT's existing access point count of 6,600.”

McDonald’s only recent brand partnership in the U.S. is the McPlant burger with Beyond Meat  (BYND) - Get Free Report, the analysts said. But, “we believe plant-based meat remains a more niche product in the U.S., while doughnuts have widespread appeal.”

Growth Prospects

“Prospects for growth are also different. Even as demand for plant-based meat has softened, Krispy Kreme's doughnuts have exhibited strong and growing demand in the U.S.,” the analysts said.

If the partnership is fully realized, “we estimate sales could exceed $350 million,” they said. “Pastries have historically represented a negligible share of sales [for McDonald’s], suggesting that the bar for incrementality is fairly low.”

While McDonald's has axed products responsible for 2%-3% of sales, such as salads, “DNUT's doughnuts are less resource intensive, including not requiring scarce refrigerated real estate,” the analysts said.

So doughnuts would need to account for about 1% of McDonald’s sales, or 4% of breakfast sales, to be considered a success, they said.

To be sure, “various logistical concerns need to be addressed before any broad-based expansion of the Krispy Kreme product,” the analysts said. “First, MCD needs to assess demand as well as decide how to integrate product into store processes.”

Krispy Kreme Benchmark

But on the plus side, “DNUT already has a wholesale model to use as a benchmark,” the analysts said. The announcement affirmed that as it has done with other partners, Krispy Kreme will deliver doughnuts daily to participating stores, they said.

“Given the similar distribution model, we think it's reasonable to expect a similar revenue share of 25% for McDonald’s and 75% for Krispy Kreme,” the analysts said. “Assuming flow through margins on incremental sales of 30%, this would equate to about $111 million of incremental EBIT [earnings before interest and taxes]” for McDonald’s.

While the impact wouldn’t be material for the golden arches, with no incremental costs, 1% of U.S. sales translates into 1% of total EBIT,” the analysts said.

“It reflects MCD's ability to continue to innovate on menu and marketing even as competitors struggle to hold [and] preserve profits.”

Given investors’ strong demand defensive investments, the analysts raised their price target for McDonald’s to $309 from $265. The stock recently traded at $274. They have a neutral rating.

The analysts have a buy rating on Krispy Kreme with a price target of $20. The stock recently traded at $14.

“We believe a premium valuation is justified [compared to its peers] owing to DNUT's robust double-digit topline growth, extended growth runway, and higher incremental returns,” the analysts said.