On October 21, 2015, we published an article on Seeking Alpha which gave the reasons why we felt it was the right time to buy McDonald's (NYSE: MCD). Since then, the fast food chain's shares have risen by 20% while the S&P 500 is down 5%. While we're pleased with that level of outperformance, we think that McDonald's has much further to go. Here are four catalysts that we think will push the company's share price higher over the long run, with discussion of its valuation following them.
The first catalyst is that McDonald's has increased its cost savings targets since our last article on the company. It now aims to achieve $500m in net annual general and administrative costs, the vast majority of which it plans to realize by the end of 2017. This is an increase of $200m over the previous target and will be met through refranchising efforts, achieving efficiencies in the global business services space and also in streamlining multiple parts of the business. This will have a positive impact on the company's margins and could lead to higher profitability and improved investor sentiment in future.
Secondly, we think that the step to return an additional 500 restaurants to franchise ownership is a sound move. Previously, McDonald's had planned to sell off 3,500 restaurants as part of its 'refranchising' programme, but this target has been increased, and if met, will mean that McDonald's is within 2% of its long-term target of having 95% of all restaurants franchised. Not only will this have a positive impact on cost savings (and is a key reason why McDonald's has increased its cost savings target), but we feel it will also make the business more streamlined and this could positively impact market sentiment.
Thirdly, we're excited about the improvements to the customer experience. Sure, there has been a lot of discussion about the introduction of all-day breakfast and its positive short-term impact on sales in the fourth quarter of 2015, but we believe that this is only part of a growing number of initiatives which have the potential to positively impact the company's top and bottom lines in future.
For example, table service and self-order kiosks in the UK have proved popular. There is scope to roll this setup out in multiple geographies moving forward, and with all of the company's European locations now reflecting its new architecture and hundreds of US stores being reimaged, there is scope for a shift in customer perceptions of the McDonald's product and experience.
Allied to this is a renewed focus on transparency regarding ingredients and how they are sourced, which we think will continue to resonate well with increasingly health conscious consumers. As such, there is still scope for the improved experience to impact positively on sales and profit, with the positive fourth-quarter numbers being the start of a trend in this respect.
Fourthly, since we last wrote about McDonald's on October 21, 2015, there has been a major shift in the monetary policy outlook for the US. Back then, it seemed likely that there would be more than one interest rate rise over the short to medium term (i.e. at least 50 basis points) and that as a result, the US dollar would appreciate considerably during the course of 2016.
Now, though, this does not appear to be the case, and while we expected McDonald's to be hurt by a stronger dollar, we're now factoring in weaker currency headwinds and these should have a positive impact on international earnings in 2016/17. As such, investor sentiment could pick up further in the coming months due to this positive catalyst.
McDonald's now trades at a premium to the S&P 500 based on the P/E ratio, with it having a P/E of 26.8 versus 19.7 for the index. However, with McDonald's forecast to increase its earnings by 16.5% in 2016 and by a further 12% in 2017, we think there is scope for the company to at least maintain its premium over the wider index. And with it having an EV/EBITDA ratio of 14.4, we're very comfortable with its valuation and this, plus the four catalysts mentioned above, means we are still bullish on McDonald's for the long term.
Disclaimer: This article is in no way a recommendation to buy or sell any stock mentioned, nor should it be considered financial advice. These are only the author's personal opinions and you should do your own research.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.