McDonald’s stock got on a roll after breaking out in early August, as the oldest of fast-food names proceeded to scarf down its biggest monthly increase in U.S. sales in nearly a decade. Then, on Nov. 9, Dow Jones stock McDonald’s (MCD) served up its plan to keep the momentum going for the next few years. Bringing back the McRib, debuting the Crispy Chicken Sandwich, launching a MyMcDonalds loyalty program and reviving U.S. restaurant unit growth all are on the menu.
However, Wall Street’s early response to the Golden Arches’ bigger-spending plans has been lukewarm. Investors had expected instant gratification, via less spending and fatter profits. Yet juicier profits have been deferred, and now there’s a new problem: franchisees are pushing back against McDonald’s for trying to pass along a bigger share of costs to restaurant operators.
Still, analysts largely endorse the Golden Arches’ strategy to capitalize on its market position that has only gotten stronger during the coronavirus pandemic. Meanwhile, overseas operations that have lagged during the pandemic should see a rebound in 2021. So is now a good time to buy McDonald’s stock?
McDonald’s Strategy Update
On Nov. 9, McDonald’s announced it’s Accelerating the Arches plan to speed up investments in new stores and technology.
CFO Kevin Ozan said McDonald’s will spend about $2.3 billion per year in 2021 and 2022, up from $1.6 billion in 2020.
“This outlook is significantly above the ~$1.2B run rate that was expected” in coming years, wrote BTIG analyst Peter Saleh.
Spending was expected to moderate, after a period of heavy investment in technology and Experience of the Future-themed restaurant remodeling.
“This likely delays the higher free cash flow thesis investors were anticipating by at least two years, so we understand some trepidation but stress it is directly related to long-term sales growth,” Saleh wrote. He kept a buy rating and 245 price target for McDonald’s stock.
On Dec. 14, UBS analyst Dennis Geiger upgraded McDonald’s stock to buy from hold, hiking his target to 240 from 230. He cited McDonald’s “compelling and visible U.S. comparable sales catalyst paths over the next several months and through 2021.”
McDonald’s Big Ask From Franchisees
McDonald’s sometimes-strained relations with franchisees had been relatively smooth lately, as sales trends have improved and corporate management provided extra support amid the pandemic.
But all that changed earlier this month, when McDonald’s emailed franchise operators about a coming increase in their costs. The new costs, which include a temporary technology fee, shared responsibility for a tuition-support program, and a cut in Happy Meal subsidies, amount to $12,000 per restaurant or $170 million, reported Jonathan Maze of Restaurant Business. He’s since reported that franchisees have stopped all but essential communications with corporate management.
McDonald’s has said the charges have been in the works for several years, yet that raises a question: Wall Street was already disappointed in the outlook for near-term cash flows as McDonald’s accelerates its investments. Could this dispute over how much franchisees have to pay mean that the cash-flow outlook may be worse than now believed?
McDonald’s Stock Analysis
A good chunk of the climb for MCD stock came as the broader stock market hit turbulence. That’s pretty typical. McDonald’s is a defensive stock that often performs well when growth stocks falter.
Yet after notching a record high 231.91 on Oct. 16, McDonald’s stock pulled back as much as 11%. It is now about 8% below a 232.01 buy point, according to a MarketSmith analysis.
Meanwhile, McDonald’s stock chart is exhibiting some yellow flags. MCD stock fell below its 50-day moving average on Oct. 28 and has yet to retake that line. Additionally, its relative strength line, the blue line in IBD charts that tracks a stock’s performance vs. the S&P 500, hit a two-year low last week.
On Nov. 9, McDonald’s reported Q3 EPS of $2.22, up 5% from a year ago. Revenue dipped 2% to $5.42 billion amid coronavirus restrictions, particularly in international markets.
Earlier, on Oct. 8, McDonald’s said global same-store sales fell 2.2% from a year ago in Q3, a huge improvement over Q2’s 23.9% plunge.
The latest quarter’s 4.6% comparable sales gain in the U.S. came from larger group orders, especially at dinner. McDonald’s really turned up the heat in September, when comparable sales rose by a low double-digit percentage, with breakfast, lunch and dinner all seeing gains.
International markets, where drive-thrus are less common, were still recovering from coronavirus closures. Operated and franchised markets, including Australia, France, Germany, Spain and the U.K., saw Q3 comparable-restaurant sales slip 4.4%. Licensed markets, including Japan, China and Latin America, saw sales fall 10.1%.
McDonald’s Marketing Muscle
McDonald’s is reaping the rewards of its earlier patience amid coronavirus restrictions. Management held off on any big ad campaigns or menu innovations until life began to normalize, then turned aggressive in September.
In a June 16 update, McDonald’s said it would boost ad spending by $200 million to revive sales in the second half of the year, recognizing the cost in the second quarter. U.S. spending on marketing fell 70% in Q2.
McDonald’s attributed September’s double-digit gain for U.S. comparable-restaurant sales to “strategic marketing initiatives such as Spicy Chicken McNuggets and the Travis Scott meal” promotion featuring the rap star.
In the Nov. 9 strategy update, Morgan Flatley, McDonald’s chief marketing officer, said the Travis Scott meal promotion got 29 billion views across social media channels. “We’ve driven massive digital adoption of McDonald’s global mobile app, including significant lifts in registrations and retention. “
CEO Chris Kempczinski said that the effectiveness of McDonald’s promotions “opens up an opportunity for us to put our foot down (on the accelerator) and to create even greater separation between us and our competitors.”
McDonald’s said it would begin testing its MyMcDonald’s loyalty program in Phoenix soon, with a nationwide launch in 2021.
McDonald’s Ready To Enter The Chicken Wars
On the Nov. 9 update, McDonald’s said its Crispy Chicken Sandwich, with chicken, a potato roll, crinkle-cut pickles, and butter, would launch early in 2021. “Our customers loved it in test, exceeding expectations on key metrics,” said Joe Erlinger, McDonald’s USA president.
McDonald’s franchisees have pushed for a chicken sandwich to help traffic trends, with Chick-fil-A seeing a burst in popularity in recent years.
McDonald’s also introduced its McPlant-brand meatless burger in the Nov. 9 presentation. McDonald’s began testing a Beyond Meat burger in Canada nearly a year ago. Saleh wrote that he doesn’t expect McDonald’s to launch a plant-based burger in the U.S. within the next year.
McDonald’s Technology Investments
Between corporate and franchisee budgets, McDonald’s said it’s investing $1 billion per year in technology initiatives, such as its loyalty program, kiosks and digital ordering and delivery. Speeding up drive-thru times is a major focus.
In March 2019, McDonald’s announced the $300 million acquisition of artificial-intelligence tech company Dynamic Yield. The acquired AI technology is used to optimize drive-thru menus to increase purchases, while boosting efficiency and satisfaction. In September 2019, the Golden Arches announced the acquisition of Apprente, a voice-recognition technology company.
In the strategy update, McDonald’s Senior Vice President Mason Smoot said the company is testing “automated order-taking in the drive-thru.” The technology is intended to make the “ordering process easier, and more streamlined, and crew are freed up to focus on other customer-facing activities.”
Among other initiatives is a drive-thru express lane. “It lets customers using the app skip the line and get their food even faster,” Smoot said. “It may even come to them through a conveyor belt.”
How Does McDonald’s Stock Stack Up Vs. Competition?
The Retail-Restaurants industry group has fallen well below the top tier, ranked No. 82 out of 197 industry groups based on price performance and momentum.
IBD Stock Checkup shows that McDonald’s stock is a few steps behind the leaders in the Retail-Restaurants group. McDonald’s stock has a subpar 27 IBD Composite Rating, with 99 the top rating. The Composite Rating combines several key fundamental and technical factors into a single score. IBD research shows all-time stock winners often have a Composite Rating of at least 95 near the start of big runs.
McDonald’s 36 Relative Strength Rating, out of 99, is mediocre by any definition. By comparison, burger rival Wendy’s (WEN) has a 60 RS rating, Shake Shack (SHAK) is at 87 and Burger King parent Restaurant Brands International (QSR) 57.
Among leading restaurant stocks, Jack in the Box (JACK) has an 80 RS rating, while Wingstop (WING) has an 80 rating. Chipotle Mexican Grill (CMG), an IBD Leaderboard stock and part of IBD’s SwingTrader portfolio, has an 84 RS.
Is McDonald’s Stock A Buy?
McDonald’s has a history of bland earnings, but it seems to be putting in place the right ingredients and technology. McDonald’s stock still has multiple catalysts ahead, like a chicken sandwich, that could keep Wall Street excited. The Golden Arches also could get a boost from fiscal stimulus and an eventual ebbing of the pandemic. Yet management will have to resolve pretty deep divisions with franchisees over who bears what costs.
Meanwhile, McDonald’s stock has a flat base, but is stuck below its 50-day moving average. The RS line shows MCD stock has underperformed the broader market.
Bottom line: McDonald’s stock is not a buy.
As long as the stock market uptrend remains intact per IBD’s daily The Big Picture column, investors may find better buying opportunities in younger, faster-growing companies. To find the best stocks to buy or watch, check out IBD Stock Lists and other IBD content.
Please follow Jed Graham on Twitter @IBD_JGraham for coverage of the economy and financial markets.
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