Yahoo Finance Why McDonald's Stock Is Blowing the Competition Away
For the past two years, there hasn't been much to love about McDonald's Corp. (MCD) stock.
The Big Mac shop's stock price stagnated, falling 7 percent from April 2013 to September 2015. Store sales failed to grow, too many food options slowed down drive-thrus and fast-casual restaurants such as Chipotle Mexican Grill (CMG) drew more customers away. It looked bleak.
But since late September, the stock has jumped 17 percent. It's a sign of momentum MCD stock hasn't experienced since 2011. "It looks like things are turning around," says Edward Jones analyst Jack Russo.
If that's the case, what's behind this latest rally? And is it too late to join?
Who wants breakfast? Everyone, as it turns out. When McDonald's CEO Steve Easterbrook announced that the Golden Arches would start serving breakfast all day starting in October, the decision was widely cheered. It made sense for the company to offer some of its most popular options throughout the day. And while only a month in, Easterbrook says breakfast sales have outperformed expectations and helped increase the average amount that customers spend.
But what's driving MCD stock recently is same-store sales, which measures the amount of average revenue earned at each store. This had idled over the past couple of years, while rivals such as Burger King parent Restaurant Brands International (QSR) and Wendy's Co. (WEN) moved upward.
In October, though, McDonald's announced that same-store sales in the U.S. grew 0.9 percent in the third quarter. That's significant growth given McDonald's market share -- with $27.4 billion in total revenues, the company brings in nearly $25 billion more than Wendy's, and double what Yum Brands (YUM) makes with Taco Bell, KFC and Pizza Hut combined.
It was the first same-store sales growth the company had seen in two years, and it came before the introduction of all-day breakfast.
Battling boutique hamburger joints. Changing consumer tastes remains a thorn in McDonald's side. As fast-casual chains such as Chipotle and privately held Five Guys Enterprises have grown, it has slowly eaten into McDonald's sales as customers clamor for organic, fresh options. In response, McDonald's increased the number of food options, including offerings such as McWraps and the number of salads. This strategy, however, slowed down drive-thrus and made kitchens less efficient, leading to the poor same-store sales growth in 2013 and 2014.
After years of menu growth, Easterbrook reduced food options in January. But now he's ready to experiment with new items again to appeal to both upscale buyers -- those that may eat at Shake Shack (SHAK) or In-and-Out Burger -- while keeping the regular offerings you would find at a cheaper price. In the U.K., it will test three "signature" burgers made from 100 percent locally sourced beef.
But part of the reason McDonald's has seen recent growth is also due to the economy. Cheaper gas and more people with jobs creates an environment where customers have more disposable income to spend on a slightly more expensive option. Because of this, "the whole sector is doing well," Russo says.
If the economy falters, the company's attempt to sell more premium food could wilt.
McDonald's rejects a REIT. The other reason analysts are bullish on MCD stock is because of cost-cutting the company has pledged. Easterbrook says the company will cut $500 million by 2018. Plus, it has a goal of having 4,000 stores refranchised in three years, as opposed to the previous goal of 3,500. This will put more stores in the hands of franchisees, allowing McDonald's to simply collect a franchise fee without having to pony up the costs for running the stores.
However, some investors want to see the organization take a bigger move by turning its property into a real estate investment trust. McDonald's collects rent from its franchisees, creating a large influx of revenues. In 2014 alone, the company collected more than $6 billion in franchise rents, which accounts for 22 percent of all sales. Some want McDonald's to spin the management of these properties into a REIT, a separate entity from McDonald's, to save on taxes.
But the company declined to take this step, saying it could create problems with the franchise owners since a third party would own the land where restaurants operate.
Share buybacks for an expensive stock. Despite these improvements, you might have to pay a steep price to get into McDonald's. Based on 2016 earnings, it now trades at 13 times enterprise value to earnings, before expenses such as taxes and interest are added in. That's at a slight premium to its peers, which trade at a median of 12.5, says Robert W. Baird analyst David Tarantino.
Barclay's analyst Jeff Bernstein says the current valuation is based on earnings that have been depressed over the past couple of years, leading to the stagnated prices. With the all-day breakfast taking hold, there's hope that future earnings look brighter than a lit golden arch.
McDonald's sure seems to thinks so. At an investors' meeting this week, it also announced that it's returning $30 billion to shareholders, an increase from $20 billion, through dividends and share buybacks and funded by taking on more debt. It's a sign that McDonald's thinks it's "still undervalued," Russo says.
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