McDonald’s Corporation (MCD) Has Rallied 10% In The Last Month? What’s Next?


It seems that McDonald’s Corporation (NYSE:MCD) is trying to regain some of its lost ground. The company’s CEO, Steve Easterbrook, launched turnaround tactics in the face of multiple issues hurting its results in the last years and the first quarter of the current year results. For the first time in two years, the company’s same-store-sales witnessed growth in the third quarter. Still, the CEO is not completely happy with the performance and believes that there is an urgent need to do a lot to reset the business. However, investors were impressed with the recent performance of the company. As a result, the stock surged 10% in the last one-month period on the back of 14% in October alone. That raises a question as to what awaits next for the company and the shareholders.

New Menu Items Play A Key Role

One of the main reasons for McDonald’s Corporation (NYSE:MCD)’s change is the new menu items that are driving traffic, as well as sales in the third quarter. The company has been focusing All Day Breakfast as it was proving to be more popular among the visiting customers. The company did add products to it, thereby helping customers to select their own menu also for all day breakfast. Before Easterbrook entered the scene, the company was pushing dozens of fresh menu items, as well as McCafe coffee offerings. That ultimately increased the density in the back of the house, as well as falling throughput.

Currently, McDonald’s Corporation (NYSE:MCD)’s focus appears to be simplifying its operations with the all day breakfast menu gaining ground more and more. The company does not bother to shrink the menu if it does not enjoy the patronage of the customers. At the same time, it is also ready to add products. It will not be a tough thing to add since it does not need any fresh equipment or training. Easterbrook believes that the changes would fuel efficiency, as well as throughput at the store levels. Above all, same-store-sales would continue to show enhancement in the upcoming periods, thus erasing the negative factors.

Cost-Cutting Measures

It is an oft-repeated measure to reduce expenses to boost the bottom line or enhance the operating margin. McDonald’s Corporation (NYSE:MCD) and its CEO, Easterbrook, also preferred to follow the same. That would ensure growth on a slower basis temporarily, thus giving the management some time to think out of the box to address the larger issue. The food retailer’s CEO aims to cut general and administrative expenses by as much as $300 million. Hedgeye Risk Management analyst, Howard Penney, expects the company to gain more from cost-cutting measures. He also said that the food retailer would shut down approximately 800 stores that are underperforming. Total, it has about 36,000 restaurants throughout the company.

The third quarter EPS was 14 cents a share higher than the Street analysts expectations or 9.4% positive surprise, which is significant considering 1.6% recorded in the second quarter. The increasing positive percentage can be interpreted as the strengthening of its turnaround tactics, though some might reject that one quarters numbers are not enough to take it as yielding of turning around results. Penney believes that whatever McDonald’s Corporation (NYSE:MCD) has taken so far are first steps as the gains would percolate to the coming quarters. The Wall Street analysts have also started following the lead as they have steadily increasing their estimations upward. This is significant considering years of witnessing a drop.

Street Confidence Boosted

The fact is that the Street has gained confidence in the company’s stock, as well as its performance. That’s the main reason behind boosting their expectations from the chain of restaurant retailers. For instance, consensus estimations increased to $1.22 a share for the December quarter from $1.17 a share predicted two months ago. Similarly, for the current year, Street has boosted its earnings estimations to $4.86 a share from $4.69 a share two months back. Similarly, they have increased their EPS projections to $5.29 from $5.16 a share. That demonstrated the renewed confidence in McDonald’s Corporation (NYSE:MCD) shares that started uptick following the third quarter numbers.

Speculation On REIT Move

There is a speculation that the restaurant firm would launch a ‘McREIT’ during an analyst meeting. The recent report of Morgan Stanley (NYSE:MS) said that the restaurant retailer owns 70% of the buildings and approximately 45% of the land in its consolidated markets. That included 27,000 restaurants throughout the globe. The company gets at least 50% of its operating income from its franchise rents.

Penney believes that McDonald’s Corporation (NYSE:MCD) might unveil tax-advantaged structure for rental income. However, there are doubts that REIT would solve all the issues as there are fears that they don’t perform well in an increasing interest-rate environment. If by any chance, the company disappoints the investors in respect of a REIT structure, it might reflect in share prices getting dragged down, though temporarily. Such an occasion could be a buying opportunity, according to Penney.

Valuation

By the turn of the year 2017, Penney expects McDonald’s Corporation (NYSE:MCD)’s annual earnings potential to be $6.32 a share. That means the company would achieve the number a year ahead. At a price-earnings ratio of 20.5 times, the stock should be worth around $130. Similarly, the stock will be valued around $150 based on PE of 23.5 times, which is near the historical range of high.

Conclusion

The company’s turnaround tactics appear to be on a strong footing. The cost cutting is an additional factor that would drive McDonald’s Corporation (NYSE:MCD)’s EPS higher to warrant a higher valuation. The most important factor is that the company has come out of the supplier issue in China where it is recording significant growth in same-store-sales. There could be some disappointment in store due to the decision on REIT. However, that would be for a short period only.

Disclaimer: The opinions and data expressed herein by the author are not an investment recommendation and are not meant to be relied upon in investment decisions. The author is not acting in an investment advisory capacity, nor is this an investment research report. The author’s opinions expressed herein address only select aspects of potential investment in securities of the company or companies mentioned and cannot be a substitute for comprehensive investment analysis. Any analysis presented herein is illustrative in nature, limited in scope, based on an incomplete set of information, and has limitations to its accuracy. The author recommends that potential and existing investors conduct thorough investment research of their own, including detailed review of the companies’ SEC filings, and consult a qualified investment advisor. The information upon which this material is based was obtained from sources believed to be reliable, but has not been independently verified. Therefore, the author cannot guarantee its accuracy. Any opinions or estimates constitute the author’s best judgment as of the date of publication, and are subject to change without notice.

Viraj Shah

Viraj Shah has completed M.Com (Finance) and is currently pursuing his CFP. He tracks US markets along with other global markets like India very closely. He is very passionate about stocks, real estate, and technology. He also believes that money can always be made in the market.

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