Why Red Lobster Really Filed for Bankruptcy, and McDonald's Stock is a Buy

Red Lobster, the popular seafood restaurant chain famous for its shrimp and biscuits, recently filed for bankruptcy. Crippled by a combination of mismanagement, dwindling traffic, and financial blunders, the chain is a perfect case study of how not to operate in the restaurant business.

The company's decision to have its majority owner, Thai Union, as its primary shrimp supplier was one strategic misstep. Coupled with its now infamous “Endless Shrimp” deal for $20, which was heavily promoted in its restaurants, Red Lobster swallowed $11 million in losses on the all-you-can-eat deal. 

But beyond the Endless Shrimp headlines, the sale of its entire real estate holdings by its previous owner, Golden Gate Capital, was even more costly. Red Lobster was forced to lease those locations back, and spent a staggering $190.5 million in lease obligations last year.

However, the unhappy ending for Red Lobster shouldn't spook investors into skipping restaurant stocks altogether. In fact, one of our best-known restaurant giants has actually built a stable and growing base of earnings over the years by running a bustling real estate business in the back of the house. Here's a closer look at one well-run iconic restaurant chain that is profitable, pays dividends, and isn't going away anytime soon.

About McDonald's Stock

Founded in 1940 by the brother duo of Maurice "Mac" and Richard "Dick" McDonald, McDonald's MCD is the world's largest fast-food restaurant chain by revenue. Popular for its lip-smacking variety of burgers, fries, chicken McNuggets, breakfast items, and soft drinks, the company primarily operates through a franchise model, with most restaurants owned and operated by independent franchisees. The company currently commands a market cap of $185.8 billion.

MCD stock is down 12.9% on a YTD basis. The stock also offers a dividend yield of 2.59%, which is more generous than the consumer discretionary sector median. Notably, MCD has been raising dividends consistently for the past 47 years, and with a sustainable payout ratio of 53.1%, the company looks on track to become a “Dividend King” in the future.

However, setting aside its dividends, McDonald's also has some other things going for it which makes it an attractive choice for investors.

Consistent Earnings Growth

Over the past five years, McDonald's has grown its revenue and earnings at a CAGR of 4.26% and 7.90%, respectively. Notably, the company's EPS has surpassed expectations in four out of the past five quarters.

In the latest quarter, the company reported Q1 revenues of $6.17 billion, up 5% over the previous year and surpassing the consensus estimate. Adjusted EPS rose by 2.7% on a YoY basis to come in at $2.70, narrowly missing the consensus estimate.

Notably, the company's cash flow from operations was $2.39 billion, and it exited the quarter with a cash balance of $838 million. Further, it closed the quarter with a net property and equipment value of $24.7 billion.

Additionally, the company's footprint expanded in the current quarter compared to the year-ago period. McDonald's Total Systemwide restaurants stood at 42,018 at the end of the quarter, up from 40,535 in the prior year.

With its solid balance sheet and operational strength, analysts are predicting above-average revenue and earnings growth rates for the company. Forward revenue and EPS growth for McDonald's are pegged at 6.71% and 16.82%, above the sector medians of 3.67% and 5.64%, respectively.

McDonald's as Landlord

McDonald's success hinges on a clever business model that keeps its assets light. They only directly operate a small portion (5%) of their restaurants. The remaining 95% are owned and run by independent franchisees. 

This approach generates revenue in several ways. Franchisees pay a royalty fee (percentage of sales) to McDonald's, with a slightly higher rate for new restaurants opened in 2024 or later (5% vs 4% for existing). Notably, this hike in franchise fees was after almost three decades of the 4% fee, and is expected to boost the company's margins.

Additionally, McDonald's may earn rent from franchisees who lease the property from them, or they might even co-own the location through equity investment. These franchise agreements typically last for 20 years, with the option for renewal or transitioning ownership to a new franchisee after the term ends. 

By keeping their asset ownership low, McDonald's can focus resources on brand development, menu innovation, and supporting their vast network of franchisees.

Last year, McDonald's raked in rent payments from its franchisees totaling $9.84 billion.

Strategic Moves at MCD

To keep its business growing, McDonald's announced an expansion plan in December 2023, targeting 50,000 restaurants by 2027 (8,000-plus restaurants compared to now). 

McDonald's is also a huge player in the coffee business, selling nearly 8 million cups of coffee per day - making it the second-largest player in the category, behind only Starbucks SBUX. To ramp up competition, it's leaning on its new CosMC concept to see if it can challenge Starbucks' leadership in caffeinated beverages.

Further, the company's decision to expand its partnership with doughnut giant Krispy Creme DNUT will allow McDonald's to enhance its popular breakfast offerings. To that end, Tariq Hassan, the Chief Marketing and Customer Experience Officer for McDonald's USA, remarked, "Since the launch of breakfast nearly 50 years ago, we’ve continued to offer new menu items, flavors and experiences that have made McDonald’s an irreplaceable part of fans’ morning routines."

And in the current environment, McDonald's is catering to cost-conscious consumers with the launch of new value offerings, too.

Analysts Say McDonald's Is a Buy

Analysts are optimistic about MCD stock, with an overall rating of “Moderate Buy” and a mean target price of $316.19. This indicates an upside potential of about 22.5% from current levels.

Out of 30 analysts covering the stock, 17 have a “Strong Buy” rating, 2 have a “Moderate Buy” rating, and 11 have a “Hold” rating.

On the date of publication, Pathikrit Bose did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.