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

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McDonald’s (NYSE:MCD) has managed to bounce back from its March lows despite weakness in the foodservice sector amid the pandemic and high unemployment. On June 16, the company announced it had reopened 95% of its restaurants worldwide.

Despite being negative, the company’s SSSG (same-store sales growth) 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.

McDonald’s top line could sink by over 30%

Analysts expect McDonald’s to report revenue of $3.67 billion in the second quarter. That figure represents a fall of 31.3% from $5.34 billion in the previous year’s quarter. 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%.

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

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

Analysts’ EPS expectations for McDonald’s

In the second quarter, analysts expect McDonald’s adjusted EPS to fall 63.8% 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. Meanwhile, a lower share count and effective tax rate could offset some of the decline. 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.

Valuation multiples and dividend yield

The recent surge in McDonald’s stock has increased its valuation. As of yesterday, the company’s forward PE multiple was 27.6x, higher than its average forward PE multiple of 22.2x over the last three years. However, the company still trades at a discount to peers Starbucks (NASDAQ:SBUX) and Wendy’s (NASDAQ:WEN), whose forward PE multiples 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% yesterday. Starbucks and Wendy’s had dividend yields of 2.21% and 0.89%, respectively.

Analysts’ recommendations for McDonald’s

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

My take

Although McDonald’s second-quarter earnings are expected to be weak, I believe it’s one of the safer bets in the restaurant space. It has invested in expanding its drive-thru, delivery, and takeaway services, which could improve the company’s SSSG. Meanwhile, the company is highly franchised, with over 93% 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, I think investors should buy McDonald’s ahead of its earnings.

Chipotle is set to report its earnings after the market closes today. For an earnings preview, read Will Chipotle’s Q2 Earnings Boost Its Stock Price?

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