Despite several encouraging bits of news, this post presents the reasons why we give a Hold rating to McDonald’s (NYSE:MCD) stock.
Let’s start our discussions on the more positive side.
McDonald’s Q2 Financial Performance Was Solid as Usual
The second quarter‘s indicators showed strong demand for McDonald’s products.
Comparable sales worldwide rose by 9.7%, with gains in all market segments. Indeed, U.S. growth was 3.7%, while the sector for internationally operated markets gained 13.0%.
Segment for International Developmental Licensed Markets saw a 16.0% rise.
Revenues across the board dropped by 3% (albeit they rose by 3% in constant currencies). On the other hand, Sales across the entire system climbed by 4% (or 10% in constant currency).
Operating income across the board fell by 36% (or 30% in constant currencies). Results included $271 million in gains from the company’s Dynamic Yield business sale and $1.2 billion in charges linked to the sale of the company’s operations in Russia. Consolidated operating income was unchanged (up 7% in constant currencies) when these current year net charges and prior year net profits of $98 million, principally attributable to the sale of MCD’s Japan equity, were excluded.
Diluted earnings per share fell 46% (41% in constant currency) to $1.60. Diluted earnings per share for the quarter were $2.55, an increase of 8% (14% in constant currencies), after excluding prior year net pre-tax gains of $0.10 per share and income tax benefits of $0.48 per share as well as the net charges described above of $0.90 per share and nonoperating expense of $0.05 per share related to the settlement of a tax audit in France.
Although there has been a sizable decline in operating income and diluted profits per share, in our opinion, this has removed some of the ambiguity around the Russian business. This has also given investors a clearer picture of how the company will be operating soon. Not only does the business sale increase certainty, but it also eliminates significant expenditures related to maintaining closed restaurants. Since March, the corporation has lost around $55M per month due to the shutdown of Russian outlets.
The fact that McDonald’s global comparative and systemwide sales have improved despite the strong U.S. currency is also crucial to note, as consolidated revenues have only decreased by around 3%.
In our opinion, the company is now more appealing than it was in May, thanks to the second quarter’s financial results, which included the sale of the company involved in the Russian operations.
There Is Less Uncertainty on the Ukrainian Operation
The news that MCD’s would begin reopening its restaurants in Ukraine in the following months broke in August. Compared to the 850 outlets McDonald’s (NYSE:MCD) once had in Russia, MCD’s now has 109 restaurants in Ukraine. However, it is yet unknown how many of these 109 locations will soon be reopened. The company will likely open eateries in areas further from the war, such as Ukraine’s capital city of Kyiv, and western provinces.
This action, in our opinion, also marginally lessens the level of uncertainty and sends a positive message to shareholders and potential investors. We anticipate that losses associated with the Ukrainian portion of the company will become more limited with the reopening of some restaurants.
The valuation of McDonald’s stock, which in our opinion continues to be expensive, is now the primary reason we maintain our hold recommendation, even though the uncertainty we spoke about in our previous article has significantly decreased.
McDonald’s Stock Valuation
Over the past six months, McDonald’s (NYSE:MCD) stock has risen by more than 15%.
However, the macroeconomic situation and the fundamentals have not significantly improved despite the great financial performance and the decreased uncertainties. High energy and raw material costs are continuing to be a challenge for businesses, and in the near future, the uncertain energy supply in Europe over the winter may have a negative effect onMCD’s operations.
According to the conventional price multiples, McDonald’s (NYSE:MCD) is trading at a premium of over 100% relative to the median of the consumer discretionary sector, even though its price is about in line with its 5-year averages.
We believe such high valuations in the current market climate are unjustified despite the firm’s excellent business model, outstanding brand recognition and customer loyalty, and lengthy history of safe and sustainable dividends and share buybacks. However, if you currently own MCD’s stock, we do not advise selling it because it might be less volatile because it is a “safer” investment than the market as a whole.
Bottom Line
The company’s future financial performance may be more accurately predicted by shareholders and potential investors if there is less uncertainty around Russian and Ukrainian activities.
The second quarter’s financial performance revealed comparable sales increase across all segments, and the demand for McDonald’s (NYSE:MCD) products has remained strong.
On the other hand, we think the firm’s valuation is unjustified in light of the lingering macroeconomic headwinds and the unpredictability of Europe’s energy supply in the coming months.
These factors lead us to give our Hold rating.
Featured Image- Megapixl @8thcreator
