McDonald’s bottoms, plus more good news for fast food stocks

Key Points

• McDonald's had a solid Q3 and is firing a trend-following entry for fast food investors.
• The report shows strength in all markets and channels, which is good news for the industry. 
• McDonald's is the best-in-breed, trading at 22X and paying a competitive yield. 

Restaurant stocks lost traction over the summer, but the correction is over. Results from Mcdonald's NYSE: MCD and Chipotle Mexican Grill NYSE: CMG reveal consumer spending remains solid, and companies with brand, digital, and a focus on execution can produce results for investors.

Today's takeaway is that several competitive fast food names will report over the next few weeks and should produce similar results. McDonald’s is the fast food leader, serving up a tasty trend-following entry for dividend-growth investors. 

McDonald’s results are solid across regions and segments

McDonald’s had a strong quarter with strong results in all regions and segments. The company produced 14% top-line growth for revenue of $6.69 billion, 200 basis points better than expected. The top line also outpaced Chipotle’s 11% growth due to its exposure to international markets.

MCD grew 8.3% in developing and 10.5% in developed markets, which is good news for names like Wendy’s NASDAQ: WEN, which targets international growth and Arcos Dorados NYSE: ARCO, McDonald’s Latin American franchisee. 

McDonald’s core US market grew by 8.1%, led by digital, marketing, and price leverage. Jack in the Box NASDAQ: JACK and Restaurant Brands International NYSE: QSR may share this strength because they have been working on domestic/North American expansion. Regarding digital, it accounts for 40% of McDonald’s net sales in the top-9 markets, which aligns with the 36.6% systemwide digital contribution posted by Chipotle.

The only other US operator that stands out for digital is Jack in the  Box, which reports earnings in mid-November. The analysts have been lowering the bar for Jack, setting it low, expecting sequential and YOY decline. 

McDonald’s also posted strength on the bottom line with adjusted earnings of $3.19. The $3.19 is $0.20 is 670 bps better than expected and up nearly 20% compared to last year.

The strength is due to revenue leverage and operational quality, which is expected to persist. The company gave no guidance in the press release, but the CEO's commentary is favorable. Mr. Kempczinski says the year is unfolding per their expectations, and the company is in a position of strength.

McDonald’s raises dividend; analysts forecast 25% upside 

McDonald’s is a healthy dividend and attractive for income growth investors. The stock yields about 2.55%, with the 10% increase authorized in Q3. The payout ratio is about 54% of the earnings and is balanced by a healthy balance sheet. The company is on track to reach Dividend King status within the next few years, so there is every expectation that annual increases will continue.

The only downside is the price tag; the 22X P/E multiple is high for the group, but you get stability in return. 

Jack in the Box is the deepest value trading at 10X earnings, and it pays 2.8%, attractive for value-hungry investors, but there is risk in its less-recognizable brand. Restaurant Brands International pays more than 3.25%, with shares trading at 20X, offering a higher yield but also with more risk.

The highest yield is Wendy’s at 5%, trading at 19X earnings. This stock has the highest risk regarding the dividend. Still, management said the latest increase showed their confidence in the company’s strategy, and targeted earnings growth would soon be a reality. 

The technical outlook: McDonald’s fires trend-following signal

McDonald’s price action surged 3% in pre-market trading to extend a rebound that began before the Q3 release. The rebound is leading fast food stocks higher and confirms support at the 24-month uptrend line, consistent with the long-term uptrend. This EMA has produced trend-following bounces over the last 4 years and should lead to a substantial rally in share prices.

MACD and stochastic align with this move and show potential for a significant shift in momentum with ample room for the price action to run. A move to the analysts’ consensus target is worth 25% and would put the market at a new all-time high.