McDonald’s shares are up 25% in recent months. They were arguably a bit cheap back at $90 earlier this year. However, they’re undoubtedly off the value menu now, having risen to $114, a new all-time high.
Up until recently, McDonald’s had been in the doghouse. Its shares were trailing the market, and there was great concern among investors. Supposedly, the company’s best days were behind it.
Shifts in consumer preferences, particularly millennials, were going to cause long-lasting damage to the brand. As younger folks demand more organic higher-quality food, the thinking was that fast food chains such as McDonald’s, Burger King, and Wendy’s would lose their younger customers.
These health-conscious consumers would move to fast casual chains like Panera, along with perceived healthier fast food such as Chipotle. Ignore that Panera serves very high carb food that isn’t much of a step up from fast food, and that Chipotle burritos offer a diet-busting 1,000 calories or more in many configurations.
No, perception is everything, and it was viewed that McDonald’s was getting left behind as consumers moved upscale. That, along with weakness overseas, were viewed as large obstacles to McDonald’s going forward.
During 2015, perceptions have changed, McDonald’s stock is far outpacing the market, and now analysts are turning bullish. What changed?
Not that much really. The company had some terrible quarterly earnings results in 2014. In 2015, up against very soft quarterly results from last year, the company has posted comparatively strong growth. Not because 2015 has been that great, but rather because 2014 was so bad.
The company has rolled out all-day breakfast. The long-term results of this remain to be seen. On the plus side, it has driven more customer traffic and excitement for the brand.
On the downside, all day breakfast is difficult due to limited grill space in most McDonald’s restaurants. Besides jammed equipment, all day breakfast is making employees jobs more stressful, since they now have more tasks to manage.
In addition, margins are falling and average ticket price is decreasing, since breakfast items cost less, on average, than the rest of the menu. The goal is to make up for declining margins with more volume. That’s an alright theory, but in practice it won’t boost earnings much.
McDonald’s estimates the addition of all day breakfast will only add 2% to overall earnings, a modest bump that the stock market has given too much credit for.
Besides all day breakfast and comparatively better quarters versus a lousy 2014, there’s not much meat for an optimist on McDonald’s share price. The company is buying back tons of stock, which is nice, but it doing so with vast new borrowings. If the stock is overvalued at 23x earnings, which is certainly a plausible argument, then overpaying to buy back stock with borrowed funds isn’t a great idea.
And on the downside, the core McDonald’s brand just isn’t doing that well. Yes, US sales are now positive again, but they grew at less than 1% last quarter. Granted, that’s an improvement from the previous 8 straight quarters of declines, but sub-1% growth is still anemic.
Overseas, McDonald’s Japan is putting up massive losses, with sales down 20% year over year following a string of food safety scandals. Among them, it’s been claimed that McDonald’s served food with shards of human teeth, along with claims that its food was causing hepatitis. It’s been the worst year for McDonald’s Japan since that entity became publicly listed.
And McDonald’s continues to flounder in Latin America. Its franchiser there, Arcos Dorados (Golden Arches in Spanish) has seen its stock melt down in recent years. Arcos Dorados IPOed at $20 a share back in 2011 and now trades at just $3, a more than 80% loss.
The company, based in Argentina, has faced massive problems as inflation has devastated the Argentine, Brazilian, and Venezuelan markets. As the franchiser for virtually all of Latin America and the Caribbean, the collapse of Arcos Dorados has prevented McDonald’s from expanding much in the whole region in recent years.
Add in a middling recent performance for McDonald’s in China and economic weakness in Canada and Europe hurting performance in those regions. It’s tough going for the brand globally.
The millennial defection threat seems to have been overblown, McDonald’s has stabilized the core brand in its domestic market. But all day breakfast is no silver bullet, and various global issues will take time to resolve. There’s very little upside to the company’s shares at the current all-time high Price.