Image Source: Valuentum
By Brian Nelson, CFA
On a day where a high-profile stock such as Meta Platforms (META) is down more than 20%, it’s difficult to focus on the positives. But we are – we recently replaced Meta Platforms with McDonald’s (MCD) in the simulated Best Ideas Newsletter portfolio, and we’re not looking back. McDonald’s is popping nearly 4% during the trading session October 27, and we continue to point to the high end of the fair value estimate range for shares as a reasonable intermediate term target ($300 per share).
We’ve been quite concerned about the macro environment during the past several months as inflation changed from a positive catalyst to business pricing and strong equity returns in 2021 to a negative catalyst to consumer spending and discount rates in 2022. Part of our bullish thesis heading into this year was that as long as interest rates stayed reasonably low, inflation wouldn’t be as big of a negative to the stock market; in some ways, inflation could be “good.” However, interest rates have shot up considerably during 2022, putting to bed that thesis.
Though personal savings rates continue to be under pressure, checkable deposits at banks remain elevated and employment levels remain good, meaning that while investors have lost considerable wealth in the stock and bond markets during 2022, the broader economic environment isn’t as bad…yet. The economy may still have to work through a tremendously negative wealth effect and weakness in the housing market as well as areas ancillary to it. We don’t think we’ll start to see Fed policy impacting the broader economy in a material way until sometime in 2023, so keep your seatbelts fastened.
We made the move to add McDonald’s to the simulated Best Ideas Newsletter last week, as we think it is extremely well-positioned for the current inflationary environment. Not only does McDonald’s offer a mostly-franchised business model where cost pressures impact its operators more so than the corporate, but inflation and higher prices may translate into higher franchise fees. Further, on the operator level, many local restaurants are offering the 2 for $2, which is going a long way to attract value-driven and inflation-strapped customers in a higher-product-price environment. Global comparable sales at McDonald’s advanced an impressive 9.5% during the third quarter, results released October 27, beating the consensus mark of 5.8%.
We must say that we are mighty pleased.
Chipotle (CMG), on the other hand, may face more pressures from an inflationary environment, but the wave of employees returning to work in the cities may help normalize its business in the near term, especially in urban areas. We also believe that the Chipotle customer is less price-sensitive than other customers and will continue to pay up for food quality and convenience. The long lines at locations in the cities are a frequent reminder that there is no shortage of demand for Chipotle, seemingly at any price — meaning Chipotle has further room to continue to raise prices.
During Chipotle’s third-quarter results, released October 25, the fast-casual operator’s comparable sales advanced 7.6%, and while input costs may be a headwind, the firm’s restaurant margin still expanded 180 basis points in the quarter, to 25.3% of sales. The firm continues to open new restaurants at a nice clip, with 43 new locations opening their doors in the quarter (with many having a Chipotlane drive-thru). Next year, management expects to open as many as 255-285 new restaurants, a solid pace, and one that we think CEO Brian Niccol can achieve.
Concluding Thoughts
We’re huge fans of McDonald’s positioning in the current inflationary environment, and we love Chipotle’s long-term unit growth potential. Global comparable store sales at McDonald’s were up 9.5% during the third quarter, while Chipotle expects to add 255-285 new restaurants in 2023, a pace we think is achievable given the momentum behind the brand and the adoption of Chipotlane’s that were kickstarted by COVID-19 protocols. The high end of our fair value estimate range for McDonald’s is $300 per share, while that mark stands at $1,765 per share for Chipotle. We like both firms as ideas in the simulated Best Ideas Newsletter portfolio.
Tickerized for CMG, DPZ, YUM, YUMC, GRUB, DASH, UBER, MCD, ARCO, WEN
———————————————
About Our Name
But how, you will ask, does one decide what [stocks are] “attractive”? Most analysts feel they must choose between two approaches customarily thought to be in opposition: “value” and “growth,”…We view that as fuzzy thinking…Growth is always a component of value [and] the very term “value investing” is redundant.
— Warren Buffett, Berkshire Hathaway annual report, 1992
At Valuentum, we take Buffett’s thoughts one step further. We think the best opportunities arise from an understanding of a variety of investing disciplines in order to identify the most attractive stocks at any given time. Valuentum therefore analyzes each stock across a wide spectrum of philosophies, from deep value through momentum investing. And a combination of the two approaches found on each side of the spectrum (value/momentum) in a name couldn’t be more representative of what our analysts do here; hence, we’re called Valuentum.