Warning: You are about to enter the Twilight Zone.
Shares of 60-year-old-plus McDonald's (MCD) now fetch about 22x forward earnings, a pretty sizable premium to the broader S&P 500. Note this premium exists despite the Golden Arches feeling a pinch of about 50 cents a share in 2015 from the stronger dollar (pinch expected to continue) and the company's core menu continuing to struggle. McDonald's market cap is roughly $110 billion, no matter if the company sells things that run counter to the global movement toward health and wellness product consumption.
Plain and simple, the market has bought into what McDonald's CEO Steve Easterbrook has been selling. It's a story of a great American comeback, led by access to simple, cheap food, a more attentive eye on expenses and new ways of getting products in the hands of low-income consumers (touch-screen machines and a new mobile app that has amassed 7 million-plus downloads since launching a few months ago). But even as McDonald's dazzled investors with its stellar global sales gains in the fourth quarter and upbeat tone taken on the earnings call, shares only rose marginally on Monday.
The reason? Investors may now be in search of the next series of catalysts to justify paying a higher multiple (and more of a premium to the markets) to own a McDonald's comeback story. If you are bullish on McDonald's, here is what you want to start seeing from the company during the next 12 months. If these developments don't begin to surface, then it may be more worthwhile to gamble on another American comeback story ... Chipotle (CMG).
The ultimate value meal is born: McDonald's launched its McPick 2 value platform earlier this month. While Easterbrook seemed reasonably pleased with the consumer response so far, he didn't sound as if McPick 2 was the longer-term answer. In part, that is likely because of catchier value menus launched recently from Burger King (BKW) and Wendy's (WEN), even Yum! Brands (YUM)-owned Pizza Hut. Hence, the creator of the original value juggernaut in the fast-food business -- the dollar menu -- must launch something much bolder later this year.
Any new value platform must absolutely crush the promos offered by rivals -- meaning franchisees must be willing to sell things at a sizable loss in a bid to reignite pressured traffic counts and heighten awareness of improved food quality. Easterbrook hinted a better value menu is in the works for later this year -- it would be nice to hear more clues on this as execs present at investment bank conferences in coming months.
Risks are taken on the U.S. menu: Under the leadership of Easterbrook, McDonald's has aggressively pared down the size of its once-bloated menu. Take a ride through the McDonald's drive-thru and look at the menu board -- they are devoid of choice, in my view. That is actually a good thing -- customers are able to order their favorites quicker and leave to eat them faster. But for McDonald's to justify a higher valuation, it has to begin debuting successful premium burgers and other sandwiches in the U.S. Until now, overseas markets such as the U.K. are getting the best innovations from McDonald's. The sense from Easterbrook on the call is that it will be several months before McDonald's gets creative on its U.S. menus, but at least it's open to the possibility in an effort to drive interest by consumers inundated with new burger chains offering superior products.
And memo to McDonald's Twitter faithful, let's use a little common sense here -- one may pay $2 more for a burger or chicken sandwich from Shake Shack (SHAK), but it's damn better quality than anything McDonald's sells. In fact, I would argue what Wendy's puts out in terms of burgers and chicken sandwiches is superior in overall experience than what McDonald's is dishing out.
McDonald's has to post a bold global sales gain during the summer: The fast-food giant will be a big-time sponsor for the upcoming Summer Olympics. So much so that the company called out the prospect for pressure on the expense line due to its marketing plans. Ultimately, McDonald's has to use this big global stage to highlight Easterbrook's initiatives to improve customer service and food quality. If the company could introduce a new must-have item, sort of a reintroduction of the brand to lapsed consumers, all the better.
In the end, the company has to deliver its best global same-store sales gain of 2016 during the Olympics quarter. Should it do so, it would spark optimism on the brand, maintaining momentum in 2017. If the Olympics quarter sales result is sluggish, then it would likely reinforce the view that McDonald's turnaround will take longer than planned -- and may not occur to the extent the market has bought into.