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How McDonald's Stock Hit an All-Time High (and How It Could Continue)

By Luis Sanchez CFA - Jul 24, 2019 at 6:00PM

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The fast-food restaurant chain has seen its profits swell and its stock price soar. Can the company continue to deliver on growth?

McDonald's ( MCD 2.59% ) shareholders must be content. Not only is the company's stock price hitting all-time highs this month, but it's also smoking the performance of the broader market. It might seem odd that a stodgy fast-food chain is a stock-market leader, but the company has delivered solid revenue and earnings growth.

Can investors expect this success to continue?

MCD Total Return Price Chart

MCD Total Return Price data by YCharts.

Robust comparable revenue growth

A quick glance at McDonald's financial statements may stoke confusion. Top-line revenue has been declining. What gives?

McDonald's has been refranchising restaurants by offloading company-operated units to franchisees. Today, roughly 93% of total restaurants are franchised; the goal is 95%. This refranchising effort has caused total revenue to decline, as the company transitions from collecting all the revenue at company-owned restaurants to receiving a much smaller royalty from franchised units. Lower revenue is offset by franchise operators paying for restaurant operating costs.

Investors are more focused on comparable revenue growth, which measures sales growth at restaurants open for longer than one year. This metric is more reflective of the overall success of McDonald's restaurants worldwide.

The comparable revenue growth trends for McDonald's are encouraging. The company has posted 15 consecutive quarters of positive global comps growth. In recent years, this metric has been in the mid-single-digit range -- outperforming global growth in GDP (gross domestic product).

Metric 2017 2018 Q1 2019
Company-operated restaurant count 3,133 2,770 2,693
Franchised restaurant count 34,108 35,085 35,278
Total revenue growth (YOY) (7.3%) (7.9%) (3.6%)
Comparable revenue growth (YOY) 5.3% 4.5% 5.4%

YOY = year over year. Data source: McDonald's financial reports.

The company credits its success to an improved guest experience stemming from greater use of technology in its restaurants. McDonald's was an early adopter of innovations such as mobile ordering, digital menu boards, and self-ordering kiosks; these have resulted in a more convenient and efficient experience for restaurant-goers.

McDonald's and its customers have reaped the benefits of using technology to improve the restaurant experience, but the company isn't done innovating. Earlier this year, it acquired two companies with technology that can improve McDonald's drive-thru ordering and mobile app.

Higher store traffic and dollars spent show that consumers are embracing the changes at McDonald's. The company is clearly doing something right to spark growth, and the trend is poised to continue.

Rising profit margin

Another critical driver in McDonald's success has been its rising profit margin:

MCD Operating Margin (TTM) Chart

MCD Operating Margin (TTM) data by YCharts.

Higher margin can be credited to the company's refranchising efforts, revenue growth, and muted inflation.

While refranchising has the effect of reducing total revenue, it also results in higher profit margin. McDonald's has been able to refranchise thousands of units over the last five years. Franchise revenue is higher-margin because the company doesn't need to pay for employee wages or food costs. Although it still operates 2,693 restaurants, McDonald's primarily needs to worry about covering its corporate overhead expenses, which scale as revenue rises.

This ties into the other driver of rising margins, revenue growth. Because McDonald's has a relatively fixed expense base, it is able to keep expenses stable even as revenue grows -- resulting in margin expansion. Organic revenue growth, driven by strong comps growth, has resulted in revenue growing faster than costs; this has allowed more dollars to fall to the bottom line.

Finally, the economy has provided a Goldilocks environment for McDonald's to run its company-operated stores. While there has been some inflation in food costs globally, the company has mostly been able to offset food inflation with matching price increases. Labor costs have risen, but McDonald's has been able to operate more efficiently. Technology such as the self-ordering kiosks and its mobile app has enabled McDonald's to do more with fewer employees, mitigating staffing costs.

A hamburger being held by someone sitting in a car

Image source: Getty Images.

Delivery remains a large growth opportunity

Low-cost food delivery had largely been out of reach for McDonald's until recently. However, mobile ordering technology and third-party logistics services provided by companies like Uber and DoorDash have opened up delivery opportunities to fast-food chains.

On its Q1 2019 earnings call, McDonald's noted that delivery now accounts for $3 billion in annual business globally, and is growing at a rapid clip. The company offers delivery in roughly 20,000 locations around the world -- over half of all McDonald's locations.

Supporting delivery at the other half of McDonald's locations and raising awareness of the capability should help drive additional growth. Delivery plays to the company's strategy of making orders more convenient and enjoyable.

The future looks bright

McDonald's is hitting on all cylinders by showing robust organic revenue growth and margin expansion. The company is plowing ahead with its effective use of technology to improve its customer experience and operating efficiency.

Investors are betting on the company's continued success. Why shouldn't they? McDonald's is an excellent operator and a classic brand. Furthermore, this is a case in point of how an old-school company can rejuvenate its business by adopting new technology. Other mature companies should take note.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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