Shares of McDonald’s (NYSE:MCD) are presently commanding a hefty valuation. Even though the famed restaurant franchisor has showcased impressive financial results recently, there’s a caveat: the stock’s high valuation casts a shadow over these accomplishments. Sure, McDonald’s stock has lagged in recent months, and earnings growth has partially closed the gap with the stock’s valuation. Still, it remains a challenging task to fully justify its present price.
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Accordingly, I see limited upside potential moving forward, and I am neutral on the stock.
Q2 Results: Double-Digit Growth Despite Macro Challenges
McDonald’s Q2 results were undoubtedly impressive, with the company posting double-digit top- and bottom-line growth. No matter how mature this company gets, its exquisite business model remains a never-ending engine of expansion. Let’s examine!
Revenue Growth
McDonald’s maintained its positive momentum in Q2, demonstrating strong revenue growth once more, spurred by an expansion in its restaurant network and notable same-store sales figures. As the quarter closed, the tally stood at 40,801 restaurants, marking an increase of 1,105 compared to the previous year. Meanwhile, existing global outlets reported a remarkable 11.7% rise in sales. The combination of these dynamics resulted in a significant 13.6% boost in revenue, which reached $6.5 billion.
These figures clearly illustrate the sustained significance of the McDonald’s brand, a status fueled by increased visitor numbers at its outlets and a booming online presence. This success is manifested in the notable surge in same-store sales, which has surpassed the rate of inflation, indicating a thriving consumer engagement both in-store and online.
What’s the secret sauce behind McDonald’s success, you ask? Well, it’s their wallet-friendly fare that remains affordable even when economic times are uncertain. In a world where most other eateries have cranked up their prices considerably over the past year, McDonald’s has managed to stay true to its roots.
Therefore, it’s entirely plausible that consumers will continue to find the brand’s value proposition highly enticing. Consequently, it’s not a stretch to anticipate that sales growth will remain robust in the coming quarters.
Industry-Leading Margins Lead to Higher Profits
One of the standout features that makes McDonald’s truly shine is its ability to maintain impressive profit margins, a crucial driving force behind its substantial profit growth. In Q2, McDonald’s EBITDA margin reached an impressive 54.8%, expanding from 53.4% in the previous quarter and 53.5% the year before. What’s more, this margin performance surpasses that of its peers within the industry.
To put this in perspective, let’s take a glance at the recent results of some heavy hitters in the Quick Service Restaurant (QSR) arena — Yum! Brands (NYSE:YUM), Restaurant Brands International (NYSE:QSR), Wingstop (NASDAQ:WING), and Chipotle Mexican Grill (NYSE:CMG). Their EBITDA margins clocked in at 36.7%, 34.3%, 26.4%, and 21.0%, respectively. These are formidable players in the industry, yet their margins don’t even come close to the level McDonald’s achieves. This distinction is largely attributable to McDonald’s highly efficient and scalable business model, with 95% of its restaurants being franchised.
Notably, a significant portion of McDonald’s revenue stream is derived from its ownership of real estate and the royalties collected from its franchisees. Royalties typically amount to a 5% fee on the restaurant’s top-line sales. This strategic approach allows McDonald’s to reap the rewards of increased same-store sales without exposing itself to the risks associated with rising restaurant operating expenses.
The dynamic combination of McDonald’s revenue growth and expanding profit margins resulted in a remarkable surge in its EPS. Specifically, EPS soared by 24% to reach $3.17. Share repurchases worth around $2.51 billion over the past four quarters also contributed to bolstering this financial metric.
The Caveat: Record Earnings Can Hardly Justify McDonald’s Current Valuation
Following a very strong first half of the year, McDonald’s is set to achieve record earnings this year. Consensus estimates point toward EPS of $11.59 in Fiscal 2023. This implies a year-over-year increase of 14.73% and a new all-time high for the company.
Despite McDonald’s notable earnings growth helping the company improve its valuation, I still find the stock significantly overvalued. At its current price levels, McDonald’s is trading at a forward P/E of 24.3 based on Wall Street’s estimate. This is quite a richer multiple than McDonald’s past decade-long range in the high teens. An above-average valuation at a time in which interest rates are also significantly higher compared to the past decade makes little to no sense.
In the meantime, the stock’s dividend yield, which is currently hovering around 2.2%, further underscores the lack of a substantial margin of safety. While the company has been gradually growing its dividend, the yield remains on the lower side of its historical range because of the lasting P/E expansion. In my view, this suggests that upside potential may be limited, particularly given the looming possibility of a correction in the stock’s valuation.
Is MCD Stock a Buy, According to Analysts?
Turning to Wall Street, McDonald’s stock continues to showcase a Strong Buy consensus rating despite its elevated valuation. This is based on 22 Buy and four Hold ratings assigned in the past three months. At $333.19, the average MCD stock price target suggests 17% upside potential.
If you’re wondering which analyst you should follow if you want to buy and sell MCD stock, the most profitable analyst covering the stock (on a one-year timeframe) is Andy Barish from Jefferies, with an average return of 16.05% per rating and an 89% success rate. Click on the image below to learn more.
The Takeaway
McDonald’s has showcased impressive financial performance in recent times, with robust revenue growth and industry-leading profit margins. The company’s ability to maintain its brand relevance and offer affordable items in uncertain economic times has contributed to its success.
However, despite its record earnings and growth, McDonald’s stock currently has a hefty valuation that appears overextended, trading at a P/E ratio higher than its historical range. The relatively low dividend yield further suggests limited potential for future total returns. Therefore, I believe it’s prudent to remain neutral on the stock, as the suppressed upside potential and valuation risks warrant caution for investors.
