We can’t get anywhere close to McDonald’s share price with our discounted cash-flow valuation process. That doesn’t mean that shares are destined to fall, but it may indicate that the stock has pulled forward future returns. In any case, investors in McDonald’s should be cautious.
By Brian Nelson, CFA
McDonald’s (MCD) has done a wonderful job in years past, pursuing all-day breakfast and transitioning (even) more to a franchise business model, but these changes are now behind the fast-food restaurant. Our fair value estimate for McDonald’s is in the mid-$150s (its shares are trading over $200), and frankly, we’re having a very difficult time coming anywhere close to how high the market is valuing shares.
During the firm’s second-quarter results, released July 26, McDonald’s global comparable store sales advanced 6.5%, a nice pace. But that’s not the whole story, in our view. The restaurant is trading at roughly 24 times expected 2020 earnings and holds more than $30 billion on the balance sheet in net debt. The reported consolidated numbers are what we’re focusing on, and they weren’t that great at all for a company with these back-of-the-envelope valuation metrics.
Image Source: Valuentum’s 16-page Report of McDonald’s.
During the second quarter, consolidated revenues were flat with the prior year, while consolidated operating income advanced 1%. We’re not saying shares of McDonald’s are going to collapse, but we do think that investors should be exercising some caution at these levels. The company’s Dividend Cushion ratio stands at 0.4, so dividend health is something to keep in mind, too. We don’t think McDonald’s is the best idea in the restaurant space by a long shot.
With that said, we wanted to mention a few things about the restaurant space more recently. According to a July 29 post by Seeking Alpha, the best-performing restaurant stocks this year through July 26 are Chipotle (CMG), up 81%, and Wingstop (WING), up 51%. These two stood head and shoulders above the rest, while Fiesta Restaurant Group (FRGI) was on the list of the worst-performing restaurant stocks so far this year.
Though we maybe should have kept a few of these ideas open a bit longer, we’re doing an awesome job getting the right names in front of readers, and that’s what’s most important. Chipotle, for example, was a former Best Ideas Newsletter portfolio idea, Wingstop a former Exclusive capital appreciation idea, and Fiesta Restaurant Group, a former Exclusive short-idea consideration. All three were closed as winners!
Order the Exclusive here.
Restaurants – Fast Food & Coffee/Snack: ARCO, DPZ, DNKN, JACK, MCD, PZZA, SBUX, WEN, YUM
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Brian Nelson does not own shares in any of the securities mentioned above. Some of the companies written about in this article may be included in Valuentum‘s simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.