Why Are We 12% Higher Than The Market Price For McDonald’s?

by Trefis Team
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Over the past two years, McDonald’s (NYSE:MCD) has been working aggressively on several initiatives to shed its image of an “unhealthy, junk food” destination and customize its offerings to suit changing customer requirements. These changes have started showing results, with positive comparable sales leading to a growth in profits. While the burger giant has been faced with declining revenue in recent quarters, this has been a consequence of the refranchising of its restaurants that the company has been undertaking for a couple of years. The company’s long-term goal is for 95% of McDonald’s restaurants to be owned by franchisees, and at the end of FY 2017, this figure stood at 92%. This strategy has resulted in cutting costs for the burger giant, and has led to an improvement in margins, and consequently, the earnings. Another benefit of the franchise model is that the company can take advantage of the significant real estate portfolio it has built up over the years, and collect rent and royalty income in the years to come.

We have a $189 price estimate for McDonald’s, which is higher than the current market price. The charts have been made using our new, interactive platform. The various driver assumptions can be modified by clicking here for our interactive dashboard, to gauge their impact on the revenue, earnings, and price per share metric.

We have arrived at a $189 price estimate for McDonald’s based on revenue projections of $21.2 billion for 2018, a P/E multiple of 24.4, and a share count of 785.5 million. The market price stood at $168.91 as of June 8, 2018, implying our price estimate is higher by 12%.

The revenue decline of 7% expected for 2018 is a result of the refranchising efforts, as mentioned earlier. While the sales are expected to fall, we expect the comparable sales to show an improvement. This is because of the following reasons:

1. Value Meals: McDonald’s began 2018 by launching its $1, $2, $3 menu aimed toward its value-conscious customers. Earlier a similar program was discontinued in 2014 since it impacted margins adversely. However, this time around McDonald’s is confident that other cost efficiencies (around marketing and lower fixed costs due to higher traffic) will ensure that margins do not decline due to this value platform. A higher number of items per order for $1, $2, $3 Dollar Menu transactions was one of the drivers for the comparable sales growth in the first quarter, and should continue to positively impact the results this year. Moreover, the company also introduced two for $4 breakfast in mid-March, which makes MCD more competitive in the breakfast day part, helping ease the soft morning sales.

2. Technology Initiatives: McDonald’s is revamping its stores to create “Experience Of The Future” restaurants which will have self-serve kiosks and table service. The company’s mobile ordering and payment system continue to expand (in 20,000 restaurants currently) and McDonald’s is also effectively using the data captured via this platform for personalized marketing and customizations. MCD has also introduced delivery in 11,500 restaurants, through its partnership with UberEats. CFO Kevin Ozan has stated that the delivery check size is generally one and a half to two times the in-store check. Consequently, an effective use of technology is another key growth factor for McDonald’s in 2018, as it can drive the average check higher.

3. New Launches: McDonald’s launched its fresh beef burgers in select markets in the U.S. to a good response, and has intended on undertaking a national roll-out. CEO Steve Easterbrook noted that in the pilot markets of Dallas, “90% of customers who tried the burgers said they’d buy them again.”  The company has also launched its premium burgers in other countries, such as Gourmet Creations in Australia and Mighty Angus in Canada. Increased sales of these products can help to increase the average revenue per consumer.

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