Why Key Analyst Sees 20% Return at McDonald’s

McDonald’s Corp. (NYSE: MCD) has made huge strides in its turnaround in just the past six months. The advent of All-Day Breakfast helped make this stock one of the best performing components of the Dow in 2015 and even since. As a result, one key independent research firm weighed in on the golden arches.

Argus upgraded McDonald’s to a Buy rating from Hold and setting a target price of $140. The company is making progress on its turnaround plan, and posted strong growth in comp-store sales, operating margins, and EPS in the fourth quarter. In addition, it is increasing the number of company-owned restaurants that it plans to sell to franchisees, as well as benefiting from lower food costs.

On the fourth-quarter conference call, CEO Steve Easterbrook also said that the company expects revenue growth in all segments in 2016. Argus thinks that prospects for continued improvement in comps and increased share buybacks, along with the 3.0% dividend yield, will attract investors. Its $140 target, combined with the dividend, implies a potential total return of 19% from current levels.

The firm noted that consumer discretionary earnings are expected to increase 13.2% in 2016 and 9.4% for all of 2015, following growth of 10.3% in 2014. On valuation, the 2016 projected price-to-earnings (P/E) ratio is 18.3, above the market multiple of 16.4. The sector’s debt ratios are high, with an average debt-to-cap ratio of 52%. Yields are below average at 1.6%.
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Argus said in its report:

In our view, the current MCD share price inadequately reflects the benefits of management’s turnaround plan. MCD shares are trading at 21.9-times our 2016 EPS estimate and at 19.8-times our 2017 estimate, compared to a historical range of 8-21. They are also trading at a 2015 EV/EBITDA multiple of 9.8, slightly above the peer average. Based on our expectations for above-peer-average earnings growth, we expect the shares to outperform those of other restaurants. Our target price of $140, combined with the dividend, implies a potential total return of 19% from current levels.

Shares of McDonald’s were trading at $120.71 on Wednesday, with a consensus analyst price target of $124.14 and a 52-week trading range of $87.50 to $121.90.