In May 2022, we wrote an analysis on the McDonald’s Corporation (NYSE: MCD) and we concluded that the action, at that time, qualified as “retained”. The analysis focused on the pros and cons of buying MCD stock. Benefits included: regular share buybacks, safe and sustainable dividend payments and strong first quarter financial performance. On the other hand, we highlighted the uncertainty related to the Russian-Ukrainian conflict and the relatively high valuation as main drawbacks.
In this article, we present additional arguments why we still believe after several months that the stock is not yet a buy, despite some positive news.
Let us resume our arguments from the most optimistic side.
Financial performance remained solid in the second quarter
Numerous metrics indicated in the second quarter that demand for MCD’s products remains strong.
1.) Worldwide comparable sales increased 9.7%, reflecting positive comparable sales across all segments:
- The United States increased by 3.7%
- The international operated market segment increased by 13.0%
- The international licensed development markets segment grew by 16.0%
2.) Consolidated revenue decreased 3% (3% increase at constant exchange rates).
3.) System wide sales increased 4% (10% at constant currencies)
4.) Consolidated operating income decreased by 36% (30% at constant exchange rates). The results include charges of $1.2 billion related to the sale of the company’s Russia business and a gain of $271 million related to the company’s sale of its Dynamic Yield business. Excluding these current year net charges and prior year net gains of $98 million, primarily related to the sale of McDonald’s Japan shares, consolidated operating income was flat (up 7% at constant exchange rates).
5.) Diluted earnings per share was $1.60, down 46% (41% at constant exchange rates). Excluding the net charges described above of $0.90 per share and non-operating charges of $0.05 per share related to the settlement of a tax audit in France, diluted earnings per share for the quarter raised to $2.55, an increase of 8% (14% at constant exchange rates), also excluding prior year net pre-tax earnings of $0.10 per share and tax benefits of 0, $48 per share.
While the decline in operating profit and diluted earnings per share is significant, in our view it removes the uncertainty associated with the Russian business and provides investors with a clearer picture of the company’s operations in a near future. Selling the business not only provides more certainty, but also removes significant costs associated with keeping restaurants closed. The closure of Russian sites since March has cost the company about $55 million per month.
It’s also important to note that despite the strong US dollar, MCD’s worldwide comparable sales and system-wide sales continued to grow, while consolidated revenue only declined approximately 3%.
In our opinion, the financial results of the second quarter, including the sale of the activities related to the Russian activities, make the company more attractive than in May.
The uncertainty linked to the Ukrainian operation is reduced
In early August, news broke that MCD would begin reopening its restaurants in Ukraine in the coming months. McDonald’s has a total of 109 restaurants in Ukraine, which is significantly less than the 850 locations they previously had in Russia. However, it remains unclear how many of those 109 locations would be reopened in the near future. The company is likely to open restaurants in territories further away from the conflict, including the capital, Kyiv, and western parts of the country.
We believe that this decision also slightly reduces uncertainty and gives an optimistic signal to shareholders and potential investors. With the reopening of some restaurants, we expect the losses related to the Ukrainian part of the business to reduce.
Although the uncertainty we discussed in our previous article has been largely reduced, in our view, the valuation of MCD stock remains high, which is currently the main reason why we maintain our holding rating.
Since our previous post on May 16, MCD’s stock price is up around 4%, while the broader market is down over 2.5%.
On the other hand, despite the strong financial performance and reduced uncertainty, macroeconomic conditions and fundamentals have not improved dramatically. High commodity and energy prices continue to create headwinds for businesses and the uncertainty of energy supply in Europe during the winter months could also impact MCD’s business in the near term. .
Based on traditional price multiples, while MCD trades roughly in line with its own 5-year averages, it trades at a premium of more than 100% to the consumer discretionary sector median.
Despite the high-quality business model, superb brand recognition and customer loyalty, the company’s long history of safe and sustainable dividends and share buybacks, in our view, such high valuations in the current market environment are still not justified. On the other hand, if you already own shares of MCD, we would advise against selling them, as they may be less volatile due to their “safer” nature than the general market.
Key points to remember
Reducing uncertainty related to Russian and Ukrainian operations could help shareholders and potential investors better assess the company’s financial performance in the future.
Demand for MCD’s products remained strong and second quarter financial performance showed comparable sales growth across all segments.
On the other hand, we believe that the valuation of the company is still not justified, due to the continued macroeconomic headwinds and the uncertainty of the energy supply in Europe in the coming months.
For these reasons, we maintain our retainer rating.