McDonald's Rising Shares Are Too Optimistic On Turnaround

| About: McDonald's Corporation (MCD)

Summary

MCD reported another quarter of lackluster revenue numbers.

New CEOs turnaround plan centers around cost cutting when increasing sales is needed.

MCD stock trades in line with sector and market on an earnings basis but lags significantly on projected growth rate.

Today we are looking at the relative value of McDonald's (NYSE:MCD) as the shares have performed well relative to the market as late. The company is in the midst of a turnaround having recently installed a new CEO and attempting to reverse a slide in same store revenues.

In their most recent earnings MCD sales slide continued with comparable stores revenues declining by 0.7%. Currency headwinds exacerbated the slide with revenues down by 10% albeit with a modest increase of 0.1% on a constant currency basis.

MCD Turnaround Plan

The new CEO, Steve Easterbrook, laid out a his plan for turning around MCD's lackluster performance. Firstly, MCD is being restructured to four new market segments.

    • US Segment that accounts for more than 40% of 2014 operating income
    • International Lead Markets - that includes established markets representing another 40% of the company's operating income
    • High Growth Markets - markets with high growth potential and expansion opportunities
    • Foundational Markets - representing the remaining markets not included above.

Secondly, MCD announced plans to deliver expense savings with the specific targets to re-franchise 3.500 restraints and increase the global franchise rate to 90% from the current 81%. This is expected to deliver more than $300 million in annual cost savings. In addition MCD affirmed its commitment to delivering $18-$20 billion to shareholders over 3 years ending 106.

Relative Valuation Matrix

 

MCD

Consumer Discretionary

S&P 500

Forward P/E

19.55

20.59

18.62

5 Year Growth Rate

7.13

17.97

11.36

Dividend Yield

3.39

1.47

2.07

       

Source

Yahoo Finance

S&P

S&P

The above table evaluates MCD's current valuation versus the S&P 500 and consumer discretionary sector. MCD trades largely in line with both the consumer discretionary sector and the S&P 500. Looking at projected earnings growth rates MCD lags the consumer discretionary sector significantly. The sector is expected to grow more than twice as fast, which should come as no surprise given investors expectations that MCD must execute a turnaround. In comparison to the S&P 500 MCD's growth rate trails but by a less substantial margin. One area that investors can be more optimistic is MCD's dividend yield that is more than double the consumer discretionary sector and 50% greater than the S&P 500.

Given MCD's lackluster projected growth we view the shares as expensive given the earnings multiple is in line with the rest of a much faster growing consumer discretionary sector and the S&P 500 overall. While a modest earnings multiple is warranted for like earnings growth given MCD's long operating history and current dividend yield a PE to Earnings growth ratio more than double the sector is too substantial to over come.

Final Thoughts

MCD turnaround plan emphasized an effort to increase the mix of franchised restaurants and reduce costs but has done little to address the decrease in sales. While the cost cutting and shareholder returns are encouraging, we would view MCD need to address the revenue side and remaining relevant to consumers where they've lost shares to more aggressive rivals as far more critical. Time will tell if the new management team will address those concerns, however given the relative valuation we would recommend investors hold the stock for income and safety and avoid any further purchases.

Disclosure: I am/we are long MCD.

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.

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