EUR 850.00 For Business Accounts Only

Morningstar | EOTF Positions McDonald's for Long-Term U.S. Comp Growth, Despite Near-Term Promotional Tweaks

Much of the focus coming out of McDonald's second-quarter update was the need to augment its $1-$2-$3 menu with greater deals amid industry competition and the potential for disruptions from Experience of the Future, or EOTF, restaurants conversions (1,300 the past quarter, with plans for 4,000 for the full year), the rollout of fresh beef, and tweaks to breakfast advertising plans. However, we remain confident that the changes McDonald's is making to modernize its consumer experience set the stage for U.S. comp acceleration beyond 2018. Our conviction continues to stem from McDonald's international lead markets (4.9% comps), where U.K., France, and Canada--markets where EOTF is in advanced stages--continue to drive strong results despite having gone through some of the implementation issues that the U.S. is experiencing. We plan to trim our back-half U.S. comp assumptions to 2%-3% from 3%-4%--which factors recent food safety issues, which have not had a material impact on sales--but remain confident in acceleration to 3%-4% longer term through positive menu mix and guest traffic catalysts (including kiosk ordering at EOTF locations, additional delivery locations, and mobile order awareness) and as the company integrates greater deal into promotional strategies.

There is no change to our $190 fair value estimate, and we continue to see shares as undervalued while offering an attractive dividend yield (over 2.5%). While valuations have contracted across the industry as refranchising activity has wound down and transaction growth has remained elusive, McDonald's remains in a favorable position because of its menu, restaurant experience, and technology pipeline (which should also be additive to the brand intangible asset behind our wide moat rating). While some of these investments will weigh on near-term margins, we still see a path to mid-40s operating margins by 2019-20--versus 42% year-to-date--through refranchising and operating leverage from new sales layers.