- McDonald's US-growth comes from share gains from other restaurants.
- Innovation, all-day breakfast and a strong value menu are driving same-store sales growth.
- Despite a 16% drop in share price, McDonald's is still priced well above average valuation.
As the bull market continued on, I became less and less enthusiastic about many of the 'blue chip' dividend payers in the S&P, including McDonald's (NYSE:MCD). Back in 2015 I was dubious about buying McDonald's despite the company's new turnaround plan. That was a mistake, as shares at the time were still under $100, and even now, after a big drop, are still $148.
On March 29th, 2016 I recommended 'taking some McDonald's off the table,' as I thought shares had run up too much. That was a good call for the short term, as shares did slide from $127 at that time to as low as $114 later that year, but things really turned around on continuing strong results toward 2017.
Courtesy of Google Finance.
Admittedly, my own record on McDonald's has been pretty mixed, and since shares really levitated last year, I threw my hands up and let it be. Then this happened: McDonald's took a big hit during the correction a couple weeks ago, then took another hit to the chin when analysts downgraded the stock on some doubt about the $1, $2, $3 value menu. Since its high in late January, shares of McDonald's are down a staggering 16.8%. That's a big move over events that are, frankly, not such a big deal.
That's why I'm taking another look at McDonald's today. McDonald's has gone from 'turnaround mode' into growth mode, and this article looks at that ongoing process. In addition, this article looks at McDonald's valuation in light of the recent drop.
Turnaround into growth
In the US, spending on going out to eat is pretty much flat year-on-year. The pie isn't expanding. That means, if McDonald's wants to grow domestically, it is going to have to take share from others. It has been doing that, and doing it well for the last couple years. Such has been the case for last quarter. Global comparable sales increased 5.5%, with system wide sales increasing 8% on constant currency terms. Comparable sales were up 4.5% in the US, which is fantastic.
McDonald's did sell off its China/Hong Kong franchise, which is unfortunate, particularly because it was privately spun off and we can't invest in it. The UK and Canada also did particularly well, as the 'international lead segment' saw comparable sales increase 6.0%. Consolidated operating income increased 6% in constant currencies; which is not bad at all. Diluted EPS was up 16% in constant currencies.
What's behind all this? All day breakfast is definitely helping, but it's more than just that. The $1, $2 and $3 value menu is also helping out a lot, and bringing in value-minded customers. Delivery in the US is also having a good effect through UberEATS, which allows customers to simply order over the smartphone and have someone deliver it via Uber.
This year McDonald's will invest another $2.4 billion of capital, most of which will go to accelerated deployment of the "Experience of the Future" plan, which involves self-ordering kiosks and a digital touch menu, as well as some other adaptations. Development plans also include 1,000 new restaurants, 75% of which will be funded by McDonald's network of licensees and affiliates.
Can McDonald's continue to win share forever? Probably not, but customers definitely are responding to the innovation and customer-centric changes that McDonald's has enacted. Investments in technology are having a really good customer response, namely increasing customer satisfaction, plus I would not be at all surprised if these changes increase margins in the long run.
McDonald's is down a lot lately, but it's also been up a lot over the past few years. According to data from FAST Graphs, McDonald's has averaged 18.9 times earnings over the course of the last ten years, but even after the big drop McDonald's trades at 21.7 times trailing earnings per share. So, even with this big drop McDonald's, it still trades at a premium of 15%.
Is that a big deal? Well, I think it depends upon your situation. Consensus expectations is for 14% EPS growth for McDonald's in 2018, but dividends have only been increased by mid single digits for the last four years. Will we see dividend acceleration? I think that we will, because right now the dividend is only 58% of trailing EPS. I don't see McDonald's letting that dividend ratio get much lower, and because earnings are expected to grow double digits, I do believe there will be some dividend acceleration.
I'm not going to recommend McDonald's here, not generally at least. However, full disclosure, I just bought some last Friday, and I did so because I lack blue-chip S&P 500 stocks in my various dividend portfolios. I have too much exposure to things like MLPs, REITs and energy companies, and so having McDonald's was a welcome change. Whether you want to add some McDonald's really depends on your personal situation. I will keep a close eye on this, though.
If you're interested in McDonald's, feel free to follow me here on Seeking Alpha. As I mentioned, I am personally long this stock.
However, I write about topics at much more regular intervals in my Marketplace service, Streaming Income. In that service I write about broader themes and provide multiple actionable ideas for income investors. I invite you to take a risk-free look.
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Analyst’s 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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