Is McDonald’s a ‘Buy’ Ahead of Its Q2 Earnings?

McDonald’s has managed to bounce back from its March lows despite weakness in the foodservice sector amid the pandemic and high unemployment. On June 16, McDonald's announced that it had reopened 95 percent of its restaurants worldwide.

Despite being negative, the company’s same-store sales growth (SSSG) in May improved significantly from April. Along with these announcements, investors’ optimism over the economy reopening and progress in vaccine development boosted the company’s stock price. McDonald’s is set to report its second-quarter earnings before the market opens on July 28. Let’s look at analysts’ expectations for the quarter.

Analysts expect McDonald’s to report revenue of $3.67 billion in the second quarter. That figure represents a fall of 31.3 percent from $5.34 billion in the second quarter of 2019. Amid the pandemic, the company had to close some restaurants temporarily. The restaurants that were opened operated only through carry-out or delivery service, and their dining spaces remained closed. These factors could drag down the company’s SSSG. For the first two months of the quarter, McDonald’s reported negative SSSG of -29.8 percent.

The company’s U.S. SSSG was better than other segments at -12 percent. Its international segment reported an SSSG of -53.4 percent, while international developmental licensed markets reported SSSG of 26.2 percent. The SSSG for all three segments improved considerably in May compared to April.

Opening new franchised restaurants in the last four quarters could offset some of the declines. At the end of the first quarter, McDonald’s operated 36,347 franchise restaurants, which was 886 more than at the end of the second quarter of 2019. Meanwhile, its company-owned restaurant count fell by ten units.

In the second quarter, analysts expect McDonald’s adjusted EPS to fall 63.8 percent year-over-year to $0.74 from $2.05. Lower sales, a weaker EBIT margin, and higher interest expenses could drag down the company’s EPS. A lower share count and effective tax rate could offset some of the declines. Sales deleveraging due to negative SSSG, increased employee hygiene and cleaning expenses amid the pandemic, and higher delivery expenses could pressure the company’s EBIT. In March, the company raised an additional $6.5 billion in debt to strengthen its liquidity, which could raise its interest expenses.

The recent surge in McDonald’s stock has increased its valuation. As of yesterday, the company’s forward PE ratio was 27.6x, which is higher than its average forward PE ratio of 22.2x over the last three years. However, the company still trades at a discount to Starbucks and Wendy’s. Their forward PE ratios are 32.7x and 37.2x, respectively.

Yesterday, McDonald’s board announced quarterly dividends of $1.25 per share, which represents an annualized payout of $5 per share. The company’s dividend yield stood at 2.61 percent yesterday. Starbucks and Wendy’s had dividend yields of 2.21 percent and 0.89 percent, respectively.

Since McDonald’s update last month, analysts have turned bullish. KeyBanc, BMO, SunTrust Robinson, Jefferies, Cowen, Piper Sandler, and Stifel have all raised their target prices. Jefferies and BMO have given the highest target price of $220, while Stifel’s target price is the lowest at $182. Analysts’ consensus target price is $198.46, which implies a 12-month return of 7.9 percent. Among the 35 analysts covering McDonald’s, 71.4 percent suggest a buy and 28.6 percent suggest a hold. None of the analysts suggest a sell.

Although McDonald’s second-quarter earnings are expected to be weak, it is one of the safer bets in the restaurant space. The company has invested in expanding its drive-thru, delivery, and takeaway services, which could improve its SSSG. McDonald's is highly franchised, with over 93 percent of its restaurants operated by franchisees. Therefore, the sales decline could impact the company less than other companies that own and operate more of their restaurants. Given that the company trades at a discount to peers, investors could buy McDonald’s ahead of its earnings.