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Why McDonald's Can Keep Beating the S&P 500

- By Robert Stephens, CFA

Despite rising 20% in the last year, McDonald's Corp. (MCD) could deliver further stock price growth. The company is implementing a strategy that focuses on innovation, technology, delivery services and its international growth potential.

Although there are risks facing the fast-food restaurant sector, the company's promotional strategy may differentiate it from competitors.


Having delivered double the growth of the S&P 500 in the last year, the stock appears to have further capital growth potential.

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Innovation

Increasing investments in technology are set to boost the company's competitive advantage. The acquisition of technology company Dynamic Yield, which was recently announced, will allow McDonald's to tailor its drive-thru menu based on time of day, trending menu items and weather in order to improve customer service. It will also improve efficiency and productivity by suggesting items that have lower preparation times during peak periods. The technology is set to enhance the company's mobile app through the use of artificial intelligence, with further personalization expected to boost customer engagement levels.

McDonald's is seeking to further improve the customer experience through encouraging shared learning across its global operations. It plans to implement menu items that are popular with customers in one region into other geographical markets, allowing it to provide customers with more choices. For example, it recently introduced Cheesy Bacon Fries in the U.S. following their success in Australia..

Growth areas

With consumers demanding higher levels of convenience, the company's delivery opportunities are set to catalyze its financial performance. McDonald's now offers delivery services in over 20,000 restaurants in more than 75 countries, which amounts to half of its restaurants globally. It plans to further scale its delivery business, leading to incremental sales growth without cannibalizing existing sales. Continued investments in making customers aware of "McDelivery" is likely to enhance its growth rate over the long run.

The company's investments in China are helping to differentiate its offerings within a competitive market. It has introduced a new everyday value offering that compliments its Extra Value Meal. It also opened over 90 new restaurants in the most recent quarter across China. McDonald's plans to open 400 more new restaurants in the current fiscal year. Since the company is set to optimize products such as the Big Tasty in established international markets such as France and the U.K., its international growth rate could improve further.

Risks

The increasing number of hamburger chains operating across the U.S. could threaten McDonald's growth rate. Evidence of this can be seen in the most recent quarter's comparable guest count, which was negative. In addition, consumer confidence has been lower in recent months. The University of Michigan consumer sentiment measure fell to 91.2 in January, the lowest level since late 2016. This could lead to reduced demand across the quick-service restaurant industry, which may negatively impact investor sentiment toward the sector.

In order to differentiate itself from peers in an increasingly competitive market, McDonald's plans to introduce new promotions. The "2 for $5 Mix and Match" deal performed well last quarter, while the introduction of Donut Sticks at breakfast was popular with customers. In addition, the company's restaurant modernization program has continued, converting 400 more restaurants to the new layout last quarter. It plans to complete 2,000 renovation projects this year, which could further enhance the customer experience.

Outlook

In 2019, McDonald's is expected to grow earnings per share by 7%.

Although the stock trades with a price-earnings ratio of 26, its strategy could lead to improving growth over the long run. An increasing use of technology may boost customer engagement levels as well as enhance brand loyalty. Similarly, its delivery service is likely to become more popular, while a focus on improving the customer experience could enhance its differentiation in an increasingly crowded market.

Having outperformed the S&P 500 over the last year, the stock could continue to beat the index over the long run.

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This article first appeared on GuruFocus.