Legendary fast-food firm McDonald's (MCD) has seen its shares fall into correction territory in recent months, thanks in no small part to the stock market's seasonal September slump. Indeed, concerns have shifted back to the Fed, future rate hikes, and the potential for the economy to stall further. As a fast-food giant with one of the best value propositions out there, McDonald's was designed to perform well in these types of choppy economic waters. So, as shares continue to sink under their own weight, contrarians should be lovin' the entry point.
Just two weeks ago, McDonald's was slapped with a notable upgrade from Wells Fargo analyst Zachary Fadem, who went so far as to call the firm "best in class," and cited "innovation tailwinds" and a "flight to value" as two potential catalysts that could drive the shares higher.
I think Mr. Fadem, who has a $310 price target (around 15% upside from here) and an outperform rating, is completely right. However, the market's positive initial reaction to the upgrade did not last long. For now, the weight of the September stock slump seems to be just a bit too heavy to shrug off, and MCD is currently down about 10% from its late-June closing high.
It's Not Just Innovation That Could Propel McDonald's Operating Margins Higher
McDonald's is a stellar operator, and its impressive operating margins (just shy of 42%) really speak for themselves. Looking ahead, the company can explore various initiatives to propel both margins and propel foot traffic. Most notably, doubling down on digital tech (McDonald's has one of the best apps in the industry) and high-value offerings could help the company gain market share in a quick-serve restaurant scene that's likely to face increased challenges moving forward.
Perhaps the biggest driver of operating margins could be an aggressive shift toward "small format" restaurants. I've noticed that an increasing number of new McDonald's restaurants have more digital kiosks and far fewer tills. The next step seems to be less dedicated space for dining in, as consumer trends gravitate toward takeout. Undoubtedly, ordering ahead via takeout or drive-thru seems to be the simplest way to minimize wait times and remove friction from the process.
New Store Concept, New Opportunity
With the new "CosMc" small-format model, McDonald's looks to be taking efficiencies to another level, as it aims to serve more people with a smaller real estate footprint. Undoubtedly, the key to success for the spin-off store concept is to maintain the consistency of quality that McDonald's customers are used to. If it can, I have no doubt that the new small concept could be an incredible profitability engine that fast-food rivals will want to duplicate.
For now, only time will tell if the new model will be a hit among consumers. If it is, McDonald's stands out as an industry pioneer as such locations look to serve more people while taking up less space and requiring fewer employees, thanks to the help of autonomous and digital innovations.
It's hard for me not to view McDonald's as the most tech-savvy company in the quick-serve restaurant market. Though plenty of competitors have their own apps and even digital kiosks, McDonald's seems to be thinking ahead of the competition every step of the way.
An Old Mascot Could Be Key to Marketing the New Concept
It isn't just the potential for CosMc's to improve fundamentals that should have investors excited. As a pioneer in staying relevant to broad consumer bases (from young to old), McDonald's is also master at marketing.
Given the recent success of its Grimace meal, I do think tapping into its old mascots could unlock marketing firepower for the firm. For the new CosMc locations, the firm is bringing back a mascot that goes by the same name, and one that's been hibernating for around 30 years!
Given the margin- and sales-driving potential of CosMc's and the power of a long-time mascot behind it, I find it absurd that MCD trades at just 24.8 times trailing price-to-earnings.
The Bottom Line on McDonald's Shares
Undoubtedly, the fast-food dining room seems to be losing its luster of late. And McDonald's seems to be taking notice, with plans to build out its new "spin-off" store concept in CosMc's. Of course, don't expect the spin-off concept to overtake traditional McDonald's locations as they begin rolling out next year.
The dining room isn't going the way of the dodo bird quite yet. In any case, management seems to be on the right track as it looks to explore new ways to bring quick-serve giants into the modern age.
At the end of the day, the key to thriving in fast food is offering low-cost, high-quality food at a fast pace - and it's hard to get all three (value, quality, and speed) on point to the magnitude that McDonald's has.
On the date of publication, Joey Frenette had a position in: MCD . All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
