McDonald’s Breakfast, Starbucks’ Afternoons

Two of the most well-known brands are focusing on two different dayparts, but will the end game be increased competition across the board? We like the prospects for both McDonald’s and Starbucks, as we continue to be amazed at the pace of same-store-expansion at the former.

By Brian Nelson, CFA

On April 30, McDonald’s (MCD) put up yet another fine quarter, its first-quarter 2018 results marking 11 consecutive quarters the company has registered positive same-store-sales growth, a streak that has been buoyed by menu simplification efforts and ongoing strength with its all-day breakfast initiative. People don’t just love McDonald’s breakfast; it seems like some can’t live without it, and it may not matter what time of day they get their fix. This is something that we flat-out underestimated. We had been thinking about the late-sleeping crowd, not the very real idea that McDonald’s breakfast is a staple of Americana, perhaps approaching that of baseball or apple pie. We underestimated the company’s brand strength and power of all-day breakfast, and we won’t be doing that again.

During the first quarter of 2018, global comparable store sales advanced 5.5%, while global comparable guest counts advanced 0.8%. Consolidated operating income was flat on a constant-currency basis, however, as higher-margin refranchising initiatives proved to effectively be a wash in the quarter given consolidated revenue declines. Interestingly, tax reform added $0.07 per share in additional income tax expense, but excluding this, adjusted diluted earnings per share came in at $1.79, an increase north of 20% (16% in constant currencies). McDonald’s continues to be as shareholder-friendly as they come, returning $2.5 billion to shareholders in buybacks and dividends in the period. The company continues to hit the ball out of the park, from the launch of McCafe years ago to all-day breakfast today. We look forward to what’s next at Mickey D’s, but our fair value estimate of McDonald’s stands at $129 per share. Shares aren’t cheap.

While McDonald’s continues to push its all-day breakfast across dayparts, Starbucks (SBUX) is setting its sights on afternoon customers. On the company’s fiscal second-quarter conference call, Chief Operating Officer Rosalind Brewer mentioned the executive team is looking at attracting more afternoon customers, whether it be through cold-brew offerings, other refreshments or teas. We don’t doubt that Starbucks can pull in new visitors, but we think it may have to come up with something more innovative than an extension of its existing coffee/tea lines. We think Starbucks has to think big to continue to drive positive same-store sales growth into the next decade. Same-store sales during the fiscal second quarter were quite healthy at 2% on a global basis, however, as reported April 26.

Looking to the remainder of fiscal 2018, Starbucks is targeting earnings per share in the range of $2.48-$2.53 and global comparable store sales growth on the low end of the 3%-5% guidance range. The coffee giant continues to grow handily, expecting to add another ~2,300 net new Starbucks stores globally. We expect Starbucks to continue to execute upon its Rewards loyalty program, which added another 1.6 million active members in the US, representing a nice 12% clip of expansion, and we’re not reading much into the new cancer-warning laws in California either. Buybacks will continue to be forthcoming, too, with the company announcing an additional 100 million share-repurchase authorization. Our fair value estimate of Starbucks stands at $54 per share.

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