Why McDonald's Stock Turnaround May Fizzle

(Note: The author of this fundamental analysis is a financial writer and portfolio manager.)

McDonald's Corp. (MCD) shares have rebounded by nearly 9.5% since hitting a low around $148 on March 2. But signs are emerging that the recent rebound may soon fizzle out. McDonald's stock price has a fantastic run over the past three years rising by nearly 68%, roughly triple the S&P 500 increase of 27%. 

Shares of McDonald's aren't cheap, trading at almost 20 times 2019 earnings estimates of $8.23 per share, coupled with weak earnings growth could be setting shares up to drop. 

MCD Chart

MCD data by YCharts

Too Expensive

McDonald's revenue is seen falling by about 1% in 2019 to $20.91 billion, but earnings are seen climbing by nearly 8.5%. When adjusting for growth, McDonalds trades at PEG ratio of 2.31 based on 2019 estimates, making shares of McDonalds expensive. Compare that to the S&P 500, which is cheaper at 16.6 times 2019 earnings estimates of $160.77 per share, according to Dow Jones S&P Indices, and growing faster, with earnings growth of 10%. When adjusting for growth, the S&P 500 is also cheaper with a PEG ratio of 1.66.

MCD PE Ratio (Forward 1y) Chart

MCD PE Ratio (Forward 1y) data by YCharts

Growth Problem

McDonald's stock faces a cost-reduction problem because there will be increasing pressure on the company to improve operating efficiencies. Analyst estimates are forecasting earnings growth of nearly 13.9% in 2018, and almost 8.5% in 2019. But the big problem is that revenue is expected to decline by 8% in 2018, and nearly another 1% in 2019. In fact, revenue isn't seen rising until the year 2020. That means it will not be an easy task for McDonald's to continue to drive earnings growth. 

MCD Chart

MCD data by YCharts

Analysts Maybe Turning Bearish

Analysts may be cooling on shares of McDonald's as well, with a downgrade from Stephens cutting the stock from overweight  to equal weight, while reducing the price target to $170 from $185 on April 16, while RBC lowered its price target to $170 from $190 at the beginning of March. But most analysts are still bullish, according to data from Ycharts, the average price target on the stock remains at around $186.50, about 15% higher than its current price around $160. 

Technical Resistance

The stock is also struggling technically and has been unable to rise above a new area of resistance, around $165. In fact, should shares continue to remain below resistance and fall below $160, it could trigger a substantial decline back to $148, a drop of nearly 9% from its current price, and a retest of the previous lows. 

McDonald's lack of revenue growth continues to plague the company, and that means growth will have to come from increased efficiencies. It makes McDonald's, trading at a P/E ratio of 20, simply too expensive. 

Michael Kramer is the founder of Mott Capital Management LLC, a registered investment adviser, and the founder of the company's actively managed, long-only Thematic Growth Portfolio. Kramer typically buys and holds stocks for a duration of two to three years. Click here for Kramer's bio and his portfolio's holdings. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein.Upon request, the advisor will provide a list of all recommendation made during the past twelve months. Past performance is not indicative of future performance.

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