McDonald's Set to Accelerate Top-, Bottom-Line Growth

McDonald's (MCD) fourth-quarter update largely served as affirmation of management's recent turnaround strategies, with global comps of 2.7% outperforming our and market expectations across most regions (U.S. comps declined 1.3%, which was anticipated following the launch of all-day breakfast a year ago) and significant progress toward removing $500 million in SG&A costs by 2018, which helped to drive 300 basis points in operating margin improvement to 32.7% during the quarter.

Now that McDonald's "foundational restoring" 2016 is in the rearview mirror, we turn our attention to several factors that will dictate the strength of the firm's wide moat and form the basis of our investment thesis in the years to come. At the top of these are the implementation of Experience of the Future operational features in the U.S. and other regions, including improved speed of service, greater menu/marketing decisions at the regional level, and adopting consumer-facing technologies, each of which should have a positive impact on guest counts as 2017 progresses and into subsequent years, supporting our five-year average global comp outlook of 3%. Refranchising plans and SG&A eliminations also reinforce our outlook calling for mid-40s operating margins over the next five years, something that may not be fully priced into market expectations. Finally, backed by expectations of improved comps and a less capital-intensive franchised business model, McDonald's should remain a compelling income play, with the possibility of more than $15 billion returned to shareholders via buybacks and dividends over the next three years.

Based on the timing of refranchising transactions, SG&A cuts, and time value of money adjustments, we plan to raise our $128 fair value estimate by a few dollars. While we'd prefer a wider margin of safety, we think longer-term investors should keep McDonald's on the radar screen due to management improvements, operational enhancements, and a strong cash return profile.

Morningstar Premium Members gain exclusive access to our full analyst reports, including fair value estimates, bull and bear breakdowns, and risk analyses. Not a Premium Member? Get this and other reports immediately when you try Morningstar Premium free for 14 days.