McDonald's: Buy at the High?
McDonald's (NYSE: MCD) has undergone a dramatic turnaround under CEO Steve Easterbrook, who took over in 2015. The company has expanded its menu, refranchised restaurants, rolled out digital ordering and delivery, and remodeled restaurants. The stock price has more than doubled during Easterbrook's tenure.
McDonald's latest earnings report shows that management's Velocity Growth Plan to transform the company's image is working as planned. The stock hit a new 52-week high following a solid third-quarter earnings report. We'll review how management is laying the foundation for future growth and whether investors should buy the stock at these elevated levels.
Image source: McDonald's.
Stellar earnings growth
McDonald's has enjoyed strong momentum over the last few years, and the results of the latest quarter kept investors feeling optimistic about the classic chain. Global comparable-store sales increased 4.2%, mostly driven by strong international comp sales growth of 5.4%. This marked the 13th consecutive quarter of positive comps.
Under Easterbrook, McDonald's has become a much leaner company. Management has refranchised some of its company-operated restaurants and trimmed overhead. The goal has been to expand the company's operating margin from the high-20% range to the mid-40% range by 2019. As of the third quarter, McDonald's is ahead of schedule, with operating margin reaching 43% year to date.
Higher margins and share repurchases led to non-GAAP earnings per share surging 19% year over year in the third quarter, as cost-cutting efforts continue to bear fruit.
How McDonald's plans to win
The only negative in the third quarter was that the U.S. segment experienced a decline in its guest count, due to a highly competitive market for value and deal offerings. However, U.S.-based restaurants still managed to post comp sales growth of 2.4% based on a favorable sales-mix shift and menu price increases.
McDonald's is undergoing an intensive remodeling of most of its U.S.-based restaurants to help attract more customers. The company plans to spend $6 billion on this effort through 2020. This involves modernizing the interiors and exteriors, as well as installing digital self-order kiosks to simplify ordering. The company is also redesigning parking areas to accommodate customers who use mobile ordering and curbside pickup.
A modernized McDonald's in Roanoke, Texas. Image source: McDonald's.
During the third-quarter conference call, Easterbrook talked about his experience visiting a recently modernized restaurant in Canada:
Like many of our top-performing markets, Canada is excelling at the fundamentals of running great restaurants. The crew members continue to set some of the highest standards of hospitality in the McDonald's system. Customers appreciate the commitment crew members in Canada have to personalized service that makes each visit enjoyable, as demonstrated by continued year-over-year increases in customer satisfaction scores.
What Easterbrook is describing is the impact that the company's new restaurant design -- called the Experience of the Future -- can have on the guest experience. These newly designed restaurants not only offer digital menu displays, self-order kiosks, and modern decor, but also guest experience leaders who offer "a little extra hospitality," as Easterbrook said in his 2017 shareholder letter.
This is the future of McDonald's, and management is quickly rolling this experience out to many markets. As this happens, McDonald's should continue to drive positive comps.
Additionally, the trend of customers ordering from mobile phones could play right into McDonald's hands. Consider that nearly 75% of the population across the company's top five markets (the U.S., France, the U.K., Germany, and Canada) live within three miles of a McDonald's. Couple that far-reaching footprint with an iconic brand, and the future looks very bright.
Should you buy the stock?
McDonald's is making necessary changes throughout the company that I believe should lead to good long-term returns for shareholders. But at the moment, there are better deals to be found than McDonald's stock.
Shares currently trade at a forward P/E of 22.6 times 2019 earnings estimates. This is more expensive than the S&P 500's forward P/E of 16.8 times earnings estimates, which gives us a good idea of the average valuation for most other world-class companies right now.
Also, the parent of Burger King -- Restaurant Brands International -- trades at 18 times earnings estimates and is expected to grow earnings 19% annually over the next five years. Analysts expect McDonald's to grow earnings just 9% per year over the same period, but it trades at a higher P/E.
Given the alternatives available to investors, I would wait for better prices before buying shares of Mickey D's.
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John Ballard has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
