McDonald's Corporation (NYSE:MCD) is up a whopping 28% year to date and appears as if it will go higher. The company announces its second-quarter earnings on July 25, where earnings, revenues and guidance numbers will be watched closely. In the company's first-quarter results, MCD really hit the mark with sales comps returning to former glory due to more focus on the quality/value premise, as well as the All Day Breakfast initiative gaining traction. I believe investors who are wary of the company's valuation and higher debt load need to focus on the company's fundamentals, which illustrate to me that there seems to be little downside risk here.
Operating margins continue to increase and, as customers get more tech savy, one would feel as if MCD's digital ordering initiative will only grow meaningfully from here. Long-term debt increased to $27 billion in the company's latest quarter, which means the balance sheet from an equity perspective looks to be at its weakest point over the past decade.
However, with the decision to re-franchise the lion's share of the company's own restaurants, as well as target significant savings in the SG&A section of the income statement, cash flow has remained buoyant to the degree that the company pulled in over $4 billion in free cash flow last quarter. This company will remain in bull mode far longer than many believe. Here is are some arguments to back up my thesis.
For example, although MCD's current earnings multiple of 27.4 is well above the company's five-year average of 19.7, this stock has proven itself to be a proven performer when times gets tough. What do I mean by this? Well, if U.S. equity markets were to fall meaningfully, MCD would hold up better than many. In fact, the restaurant chain's earnings multiple back in 2007 was actually over 30, but because earnings practically doubled in 2008, the share price was basically not affected by the carnage we saw elsewhere in 2008.
This is what value investors miss to some degree with stocks such as MCD. Why? Because a significant boost in earnings can return this stock to a more "normal" valuation. And this (like we saw back in the great recession) can be done with little damage to the share price. When the equity and real estate markets come down, one would feel that MCD will attract customers who generally eat out but are trading down. This protects the downside as the restaurant chain would more than likely gain market share once again.
So, share price consolidation is what I would see if markets in general trended down. But what about a sustained move upward? As my followers know, I monitor the weekly commitment of traders reports to see when we are going to see a big shift of capital from the bearish side to the bullish side. To date, we haven't gotten such a shift. In fact, in the most latest report, there was 14,956 reported net short contracts, which was actually a larger short number than the previous week.
One would feel that this level of short interest should have resulted in a meaningful downturn recently in the S&P 500. However, we just haven't had it, and now that the S&P has broken out to all-time highs, any notion of a significant correction in the near term seems doubtful. We need a Blees rating at nosebleed levels for a sustained period of time before we can even begin to entertain the prospect of a cyclical top in equities. Only a brave person would short MCD as equities continue to trend higher.
Sentiment in this stock is actually flat, despite the big trending move the stock has undergone. I wouldn't be surprised to see Q2 earnings become another catalyst to drive this stock higher. The market will focus on whether positive comps can once again be achieved in each market and whether operating margins can continue their sustained move north. Its all about growth, and management will be hoping that the experience of the future, fresh beef and digital ordering will be the catalysts that drive this company into the next wave of growth. I would not be betting against them at this stage.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in MCD over 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.