McDonald's (MCD) may seem like an unconventional choice for our top restaurant pick heading into 2020. Stagnant traffic trends in 2019 have called into question the lasting efficacy of the company's various "velocity drivers”, including its “Experience of the Future” store formats, digital ordering, and delivery.
Competition remains fierce, with several rivals seeing strong comparisons from plant-based burgers and premium chicken sandwiches, and promotional activity is likely to escalate into 2020. On top of this, the company recently had a high-profile management change, with McDonald's US head Chris Kempczinski assuming the chief executive reins from Steve Easterbrook in November.
While these factors are investment considerations, we still see several reasons McDonald's should be on investors' radar screen heading into 2020. Our confidence stems from new technology investments (particularly at the drive-thru), menu innovation plans, a recession-resilient brand, strong cash return qualities, and an underrated management team. Results could be choppy through the management transition in the first half of the year, but ultimately, we believe there are several positive catalysts at the forefront. In our view, the shares are enticing, at more than a 10% discount to our valuation.
Here are 10 reasons to consider investing in McDonald's in 2020:
1. It has an Unknown yet Underappreciated Leader
The sudden departure of Steve Easterbrook in November raises natural questions about McDonald's leadership under new chief executive Chris Kempczinski, who is not well known by investors. However, we believe Kempczinski is a more than capable leader who will continue (and build upon) many of the technology initiatives put in place while embracing new menu innovations that alleviate current franchisee concerns.
2. It is Seeing Growth Pick-Up
With negative comparable transaction growth in 2019, it's not surprising that franchisees and the broader market have called into question the efficacy of what McDonalds calls it “Experience of the Future” investments. But it takes time for consumers to adjust to new technology changes, and we've started to see McDonald's outperform restaurant industry traffic averages the past few months.
3. It is Transforming the Drive-Thru Experience
In 2019, McDonald’s acquired Dynamic Yield a company specialising in “personalisation and decision logic technology” and Apprente, a voice-based conversational artificial intelligence platform. These two acquisitions should not only help McDonald's reinvent its drive-thru experience but also unlock new transaction and ticket opportunities through digital and kiosk ordering over the next several years.
4. It is Unlocking New Restaurant Formats
New technologies should enable McDonald's to refine its future real estate strategy and unlock the potential for smaller-format mobile pickup or delivery hub locations. We see several benefits from such a strategy, including more consistent transaction growth and deploying McDonald's own delivery capabilities while reducing its dependence on third-party services (such as Just Eat).
5. It is Growing its Delivery Business
We forecast that McDelivery as a percentage of sales will more than double over the next 10 years, from 4% in 2019 to almost 9% in 2028. As delivery becomes a more meaningful contributor, we expect a positive impact on comparable traffic and ticket trends while potentially allowing McDonald's to explore its own in-house delivery service (and reducing its dependence on third-party aggregators).
6. It is Changing its Menu
McDonald's largely missed out on the two most significant US menu trends in 2019: plant-based burgers and premium fried chicken sandwiches. While we don't anticipate the same level of comp benefit that Burger King and Popeyes enjoyed from new product launches in 2019, we believe McDonald's will see contribution from new product launches in these categories in 2020.
7. It is Growing its Presence in China
McDonald's has had uneven results in China, but we believe the sale of its assets in China and Hong Kong to a consortium led by CITIC and Carlyle has greatly improved operations in the region. With stores generating stronger unit economics, improved digital capabilities, a loyalty program of more than 100 million members, and opportunities for smaller-format locations, we expect China restaurant openings to steadily increase over the next 10 years.
8. It is Recession-Resistant
We're not forecasting a recession in the United States in 2020, but we believe it's reasonable to expect a deceleration in industry growth trends amid difficult comparisons and the potential for asset market volatility. McDonald's tends to outperform in periods of slower economic growth, and we believe that will be the case again in 2020.
9. It is Reasonably Priced
With the restaurant industry fairly valued at current levels and facing potentially slowing growth rates in 2020, investment opportunities are scarce. Nevertheless, we believe McDonald's offers the best risk/reward profile in our coverage list on top of unique technology, menu, and capital allocation catalysts.
10. It is Investing in Itself
As it successfully wraps up its 2017-19 cash return goals of $22 billion-$24 billion, we believe McDonald's management will unveil new capital allocation plans in early 2020. While we don't expect the company to quite reach the same level of cash return over the next three years, we expect an acceleration in dividend per share growth to the low double digits over the next few years, which should satisfy income-oriented investors.
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