McDonald’s: Decent Fundamentals, but Revenue Growth Lacks Enthusiasm

McDonald’s (MCD) is the world’s leading fast-food chain that operates and franchises over 30,000 restaurants in more than 100 countries. More than 90% of McDonald’s restaurants are owned and operated by independent local business owners. The company was founded in 1955 and is headquartered in Oak Brook, Illinois.

I am bearish on MCD stock. Book value per share is negative, plus free cash flow growth and operating cash flow growth are mixed.

McDonald’s Business News

Recent news includes Mastercard (MA) announcing an agreement to acquire MCD’s personalization platform and decision engine company, Dynamic Yield. This was announced on December 21.

Next, it is not frequent news to hear that a company has filed a lawsuit against its former CEO. McDonald’s, on the other hand, announced that it successfully resolved a lawsuit against its former CEO, Steve Easterbrook, as he will return both equity rewards and cash to the company valued at more than $105 million.

Q3 2021 Earnings: A Beat and a Dividend Increase

McDonald’s had a strong quarter in Q3, beating both EPS and revenue. EPS GAAP of $2.86 was a beat by $0.38, and revenue of $6.2 billion was a beat by $158.3 million.

Year-over-year revenue increased 14%, operating income increased 18%, net income increased 22% and diluted EPS rose 22% to $2.86 from $2.35 in Q3 2020.

Other positive news included the announcement of a 7% increase in the quarterly cash dividend to $1.38 per share and the resumption of a share repurchase program. Investors looking for a dividend increase using a stock screener most probably will like the recent news.

Fundamentals – Risks

From the Q3 2021 earnings report, which was a strong one, it is hard to understand why I am bearish on the stock. Better than expected earnings are a catalyst that, in most cases, cause a rally to be imminent.

McDonald’s has several good signs. These include a Piotroski F-Score of 8, indicating a very healthy company, an operating margin that has expanded on a TTM basis to 41.6% after declining to 37.1% in 2020, a P/E ratio of 26.4x, which is close to a one-year low of 24.6x, and an Altman Z-score of 4.6, which is strong.

So, what are the negative factors for MCD stock now?

First, the revenue per share has been in decline over the past three years. MCD stock earnings show stability but lack significant growth.

Insider Activity is a useful tool to analyze stocks reflecting significant inflows or outflows of the management of companies. These movements may be either random or, in many cases, purposeful, especially if they are large in the amount of capital reported. McDonald’s corporate insider activity shows that the management sold shares worth $2.5M in the last three months.

Another risk is that McDonald’s has a negative book value of a share, with negative shareholders’ equity as of 2016.

The five-year average revenue growth of -5.45% is very poor.

Valuation

Compared to a sector median price/earnings ratio of 16x, MCD stock is relatively overpriced, with a price/earnings ratio of 26.4x. Also, compared to the sector median EV/EBITDA ratio of 10.3x, MCD is relatively overpriced, as its EV/EBITDA ratio is above 21x. McDonald’s Corp’s stock price/sales ratio of 8.5x is close to a 10-year high of 9x.

Wall Street Take

McDonald’s has a Strong Buy consensus based on 23 Buys and four Hold ratings assigned in the past three months. The average McDonald’s price target of $284.32 represents 11.2% upside potential.

Conclusion

McDonald’s Corp delivered a strong Q3 2021 earnings report, but it has negative shareholder’s equity, which itself is a very red flag in terms of valuation. Historical revenue growth does not excite me either, and the valuation seems to be rich.

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