Editor's Note: This is a recent institutional research report from our Restaurants team. For info on how you can subscribe to our research email firstname.lastname@example.org.
When we added McDonald's (MCD) as a best idea short at the end of January, we were confident that our short thesis would play out in due time. However, over the last month MCD stock has plummeted by ~16%, and we are now forced to move to the sidelines, as much more downside from here may be hard to come by (at least in the short to intermediate term).
Despite moving to the short bench, we continue to believe that MCD will struggle in 2018 for the following reasons:
- SSS in the USA for 2018 are too aggressive. Value will not be a big driver of incremental sales in 2018.
- The company increased capital spending by over 20% for 2018 (big change vs last five years of declining capital spending).
- The store level technology improvements will not drive significant SSS in 2018
- The new 2018 lowered effective tax rate (~25-27% range) results in incremental cash flows, but the absolute rate is somewhat disappointing, given the higher tax rates abroad.
- Our alternative data sets suggest a slowing in MCD sales trends.
- Short interest has grown modestly from 0.83% when we added MCD as a Best Idea short, to 0.90% most recently.
MCD continues to find itself in a precarious situation. Despite being a juggernaut in the space, on the most earnings call, the management team communicated a few tidbits of information that causes us to be concerned going forward. With CAPEX expected to come in at ~$2.4B in FY18, this would signify an approximate increase of over 20%. Also considering slowing sales, we would expect to see ROIIC decline from here.
Another factor that investors may be over-looking is that the adoption of technology among consumers could be slower than expected and may not yield the incrementality that is expected. Additionally, with other players ramping up delivery and overall focus on technology, the negatives may continue to pile up for MCD!
We will take a step back and evaluate where to take our short call from here. More details to come in the coming weeks.