McDonald's Has Peaked

McDonald’s (MCD) has been on the uptrend ever since Steve Easterbrook took over the company. McDonald’s All-Day Breakfast was a great move and has pushed the company’s shares towards all-time highs. All-Day Breakfast service was introduced by the company in October 2015 to help recover weak performance at the company’s United States based stores. The company’s same store sales dropped for successive seven quarters before the launch of All-Day Breakfast, but it surged 5.4 percent just after the launch of All-Day Breakfast service.

This was mainly because consumers preferred to eat healthier food instead of poor quality food.
Moreover, the company publicized that it will expand its all-day offerings by the month of September, that means biscuit, McMuffin, and McGriddles sandwiches will be available at all stores beyond normal serving hours.

Initially, shareholders anticipated that offering breakfast at any time of day is not an innovative idea and will not have massive impact on the company’s results, as they believe it would only cannibalize sales of lunch and dinner. However, McDonald’s recently detailed that consumers are interested in buying specific breakfast items as add-ons to their normal meals, blending hash browns or Egg McMuffin sandwiches together with fries.

On the other hand, one thing that investors are worried about is how the expansion of all-day breakfast will affect margins. As a matter of fact, breakfast items are generally of the lower margin variety compared to higher average selling price lunch items, so extension could cause some margin compression.

In Q4 and Q1, the company profited from the higher sales driven franchise margins in the United States. This clearly suggests that the company can drive margin expansion even with lesser average selling price all-day breakfast. Furthermore, it seems like the company’s valuation is aided by robust growth forecasts.

At present stage, the company is trading at 23x P/E. Throughout the upcoming five years, the company’s earnings is projected to surge at 10.5 percent per year, whereas, market is predicted to grow earnings at a 7.4 percent clip.

The earnings multiple looks conservative if you consider the projected earnings growth. However, I doubt McDonald’s can continue growing at such speed due to its size. Hence, at 23x P/E, McDonald’s looks a bit expensive.

Moreover, the company has also benefited from Chipotle Mexican Grill (CMG) losing sales, and this trend will reverse once Chipotle starts gaining back customers. Thus, I think McDonald’s has peaked and should be avoided at current levels.
Published on Jul 20, 2016
By Akshansh Gandhi

Copyrighted 2016. Content published with author's permission.

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