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McDonald’s or Starbucks, Which Is a Better Buy?

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So far this year, McDonald’s (NYSE:MCD) and Starbucks (NASDAQ:SBUX) have lost 9.0% and 18.6% of their respective stock values. Both of the companies have underperformed the broader equity markets. The S&P 500 Index has declined by 6.9%. In the first quarter, McDonald’s reported revenues of $4.71 billion, which beat analysts’ expectation of $4.65 billion. However, the adjusted EPS was $1.47, which was lower than analysts’ expectation of $1.57. Also, the company’s diluted EPS declined by 14.5% YoY. The lower-than-expected first-quarter earnings and temporarily closing restaurants led to a fall in McDonald’s stock price.

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In the comparable quarter, Starbucks also beat analysts’ revenue expectations but missed on the EPS. The company reported revenues of $6.0 billion, which beat analysts’ expectation of $5.89 billion. Meanwhile, the EPS came in at $0.32, which was lower than analysts’ expectation of $0.34. Also, the company’s management warned that the COVID-19 outbreak could have a significant impact on its financial performance in this quarter. So, the weaker outlook and lower-than-expected second-quarter performance led to a fall in the company’s stock price. So far this year, McDonald’s has outperformed Starbucks. Let’s look at analysts’ expectations for the next four quarters.

Analysts’ expectations from McDonald’s

For the next four quarters, analysts expect McDonald’s to report revenues of $18.7 billion. The amount represents a fall of 10.4% from $20.8 billion in the same quarters of the previous year. Temporarily closing restaurants or operating under a restricted capacity due to COVID-19 could drag the company’s sales down. Analysts expect the company’s sales growth to turn positive in the first quarter of 2020.

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Moving to EPS expectations, analysts project that McDonald’s could report an adjusted EPS of $5.97 in the next four quarters. The amount represents a fall of 21.4% from $7.60 in the same quarters of the previous year. Along with the sales decline, contracting margins and higher interest expenses could lower the company’s EPS. The sales deleverage from negative SSSG and higher expenses related to employee hygiene and increased cleaning amid the pandemic could impact the company’s margins.

Analysts’ expectations from Starbucks

Analysts expect Starbucks to report revenues of $23.7 billion in the next four quarters. The amount represents a fall of 11% from $26.7 billion in the same quarters of the previous year. Temporarily closing restaurants across the world and restrictions on operations could impact the company’s sales. Meanwhile, the company expects to report positive revenue growth in the second quarter of fiscal 2021.

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Starbucks owns and operates over 50% of its restaurants. The impact of sales declines on the company’s margins will likely be high compared to a highly franchised company. So, analysts project deeper cuts in Starbucks’s EPS. For the next four quarters, they expect Starbucks to report an adjusted EPS of $0.97. The amount represents a fall of 62.5% from $2.59 in the same quarters of the previous year. During this period, the company’s EBIT margin will likely contract by over 7%, while its interest expenses could rise by over 20%.

Dividend yield and valuation

Last month, McDonald’s management announced quarterly dividends of $1.25 at an annualized payout rate of $5.0 per share. Meanwhile, the company’s dividend yield was 2.71% as of June 26. Last week, Starbucks announced quarterly dividends of $0.41 per share at an annualized payout rate of $1.64. As of June 26, the company’s dividend yield stood at 2.23%.

On June 26, McDonald’s and Starbucks were trading at forward PE multiples of 26.4x and 33.0x, respectively. Both of the companies were trading higher than their average forward PE multiples of 22.1x and 26.2x, respectively, for the last five years.

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Analysts’ recommendations for McDonald’s and Starbucks

Wall Street is bullish on McDonald’s. Among the 35 analysts, 74.3% recommend a “buy,” while 25.7% recommend a “hold.” None of the analysts recommend a “sell.” As of June 26, analysts’ consensus target price was $207.28, which represents a 12-month return potential of 15.3%.

Meanwhile, Wall Street favors a “hold” rating for Starbucks. Among the 35 analysts, 60% recommend a “hold,” 37.1% recommend a “buy,” and 2.9% recommend a “sell.” Overall, analysts’ consensus target price was $80.12, which represents a 12-month return potential of 12.0%.

My take

I’m more bullish on McDonald’s. The company already opened 95% of its restaurants as of June 16. Meanwhile, the company has a high percentage of restaurants with drive-thru lanes. McDonald’s has been investing to expand its delivery services. Also, the company operates 93% of its restaurants through franchises. So, the impact on McDonald’s margins will be limited compared to Starbucks. I think that McDonald’s would be a good investment bet in the current scenario.

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