McDonald's Should Carry Momentum Into 2018
Wide-moat McDonald's (MCD) carried its 2017 momentum into the fourth quarter and now finds itself in a place of strength. In our view, the key takeaway from the quarter isn't so much that the company continues to regain lost consumers through new approaches to value (McPick 2 and $1 beverages in the U.S. and similar promotions internationally) or experience (new decor, ordering technologies, and training to improve speed of service and customer satisfaction metrics), but that it is positioned to continue these trends in 2018. Aggressive quick-service restaurant promotional activity is a risk, but we believe the combination of McDonald's new $1-$2-$3 menu, delivery (called out as a "meaningful contributor" in several markets with average checks 1.5-2.0 times in-store orders), mobile order and pay availability at 20,000 locations (14,000 U.S. and 6,000 U.K./Canada), the national launch of fresh beef in the U.S. in May/June, and menu price increases in the 2%-3% range (to offset value initiatives) should keep comps around 4% for the foreseeable future.
Tax reform gives McDonald's the chance to accelerate aspects of its U.S. velocity growth plan, with plans to invest $6 billion over the next two years (including capital expenditures of $2.4 billion in 2018) in its Experience of the Future restaurant format, which was implemented in 3,000 locations in the U.S. at year-end, with another 4,000 expected in 2018. While these and other technology and labor investments will weigh on near-term margins, we still see a clear path to mid-40s operating margins by 2019-20 through recent refranchising efforts and operating leverage from the aforementioned top-line drivers.
We're planning a moderate increase to our $170 fair value estimate for time value of money adjustments and a lower effective tax rate. While the shares strike us as fairly valued, we don't see many downside catalysts, with new sales levers becoming greater contributors and cash return levels set to accelerate.
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