Why This Analyst Is Putting McDonald's on the Back Burner

Chris Lange

McDonald’s Corp. (NYSE: MCD) has been one of the worst-performing Dow stocks in 2016. It is still positive but not keeping up with the recent market boom that we’ve seen. Considering this underperformance, one key independent research firm took a more measured perspective on the Golden Arches and how it might perform going into 2017.

Argus downgraded McDonald’s to a Hold rating from Buy, as the firm expects the company to face pressure from rising labor costs and slower comp sales. At the same time Argus lowered its 2016 EPS estimate from $5.60 to $5.50 and the 2017 estimate from $6.30 to $6.20. The long-term earnings growth rate forecast is 10%. The consensus estimates from Thomson Reuters are calling for $5.56 and $6.14 in EPS in 2016 and 2017, respectively.

Although McDonald’s posted solid second-quarter earnings, overall revenue declined from the prior year, and both revenue and same-store sales fell short of consensus expectations. By contrast, comp sales rose strongly in both the first quarter of 2016 and fourth quarter of 2015.

Management also noted a widening price gap between restaurant food and food at home, which could continue to weigh on restaurant traffic and comp sales.

Back in May, McDonald’s announced the first steps in its turnaround plan. To better focus on its most important markets, the company reorganized its operations into four segments: the United States, International Lead Markets, High-Growth Markets and Foundational Markets. The company also said that it would accelerate franchising, reduce general and administrative costs, and return more cash to shareholders.

At an investor meeting in November 2015, management said that it would return $30 billion to shareholders through dividends and buybacks in 2014 to 2016, up from its prior forecast of $18 billion to $20 billion.

According to Argus:

In our view, the current McDonald’s share price adequately reflects the benefits of management’s turnaround plan. McDonald’s shares are trading at 21.8-times our revised 2016 EPS estimate and at 19.4-times our 2017 estimate, compared to a historical range of 8-24. The shares are also trading at a projected 2016 EV/EBITDA multiple of 13, close to their five-year peak. Based on our expectations for rising labor costs and slower growth in same-store sales, offset in part by gains from restaurant refranchising, we expect limited share price appreciation over the next 12 months. As such, our rating is now HOLD.

Shares of McDonald’s were trading at $119.07 on Monday, with a consensus analyst price target of $130.29 and a 52-week trading range of $87.50 to $131.96.