Time to Take a Bite of This Stock's Enticing Value

Key Points

• McDonald's struggled in Q2 but not as bad as whisper numbers expected. 
• Strengths offset weaknesses, setting the company up to resume growth later this year.
• Cash flow and the balance sheet are healthy and can sustain dividends, distribution increases, and share repurchases. 

McDonald’s NYSE: MCD Q2 results weren’t awesome, but the miss was slim compared to the consensus estimates, and revision trends suggest the market was secretly expecting worse. All but one analyst lowered their revenue and earnings estimate over the past quarter, leading the whisper figure to be well below the consensus. The takeaway is that McDonald’s Accelerating the Arches Strategy is gaining traction, and when trading near the bottom of its trading range, McDonald’s stock is a deep value. 

The value is present compared to past performance and market expectations, suggesting a rebound is due and could be a strong one. At face value, the 21x this year’s earnings multiple and 19x next year’s are a four-year low that discounts the company’s recent growth. The comps and growth were weak in Q2, but a little giveback is nothing compared to the 10.5% growth in the last two years. Again, trading at the low end of the range, MCD stock is barely above its 2022 average price point, suggesting a 10% upside is the minimum to expect, and that target aligns with analysts' forecasts. 

The results don’t jazz analysts, but the early take is that they are satisfied with them and reaffirm the Moderate Buy rating and their recent price targets. The first revision was from Wedbush, reaffirming an Overweight rating and $295 price target, aligning with the consensus expectation for a 20% stock price advance. However, the analysts' lowest target is the most significant detail today. The low target of $265 is above the current price action, suggesting this market is at its floor with nowhere to go but up. 

McDonald’s Struggles in Q2: Growth is Still in the Forecast

McDonald’s struggled in Q2, but the quarter could have been much worse. The company reported $6.5 billion in net revenue, which is flat compared to last year's net revenue and 200 basis points shy of the consensus. Weakness was seen in the -1% global comp, blamed on weakness in all reporting segments, only partially offset by pricing increases. 

US comps fell by -0.7% on negative guest count offset by higher prices and strength in digital traffic; International Operated Markets fell by -1.1%, while IDLM fell by -1.2%. International Developmental Licensed Markets fell by 1.2%, with weakness in China compounded by war in Ukraine and Israel offset by strength in Latin America and Japan. Latin America is a critical detail for investors, growing by double digits; economic development and the growing middle class also drive strength for other consumer companies, including PepsiCo NASDAQ: PEP, WD-40 Company NASDAQ: WDFC, and PriceSmart NASDAQ: PSMT. 

The margin was another weakness, as deleveraging, increased SG&A, and non-cash impairments resulted in an 11% decline in GAAP income and earnings. However, adjusted for one-offs and comparability, earnings declined only 6%, leaving cash flow and the balance sheet in fine shape. Investors can expect the dividend growth to continue at its current mid-single-digit CAGR and for count-reducing share buybacks. Buybacks over the last year reduced the count by 2% on average in Q2 and 1% on a YTD basis. 

McDonald’s Shows Support at Critical Level

McDonald’s Q2 report wasn’t the blow-out or catalyst it could have been, but it is sufficient to lift the price action in early trading. The market is up about 1% following the news, showing support at the critical level. The critical level is the low end of its two-year trading range, where a vigorous rebound began in late 2023. Assuming the market follows through on this signal, shares of MCD could advance 3% to 5% quickly. The move could gain momentum if the market can surpass the $265 level. If not, MCD may remain range-bound near the low end of the current range.