What: Shares of global fast-food giant McDonald's (NYSE:MCD) sizzled $0.51 higher in Wednesday's trading session to finish the day at $100.25, its highest close since mid-July, following a rating upgrade and a subsequent price target increase from research firm RBC Capital Markets.
So what: RBC Capital Markets boosted its rating on McDonald's from sector perform to outperform and dramatically raised its price target, or fair valuation, for the company from $93 to $115. According to the covering analyst, McDonald's is on the verge of a turnaround in the U.S. even as its business is stabilizing in previously volatile foreign markets, which should yield potential upside for the stock.
RBC Capital focused on a plethora of possible catalysts, but in a nutshell it boils down to the idea that McDonald's trades at a discount to its peers on a fundamental basis, and RBC predicts U.S. same-store sales will turn positive in 2015. The impetus for this shift relates to a new CEO taking the helm at McDonald's, which should expedite the company's adoption of digital payment technology, narrow its menu to higher-margin and core items, improve food quality, and broaden the ability for consumers to customize their orders.
Based on RBC Capital Markets' price target, McDonald's would have 15% upside from Wednesday's closing price.
Now what: The question investors have to ask is whether this upgrade and subsequent price target hike on McDonald's makes them grimace, or if they're "lovin' it."
Brutal puns aside, a case can be made for both bulls and bears.
On one hand, McDonald's has a well-recognized global brand name, a value menu that has historically driven strong customer traffic, a unique coffee blend, and is usually at the forefront of fast-food menu and restaurant interior innovation. Its size enables McDonald's to pass along price increases when necessary, and it also commands some of the best margins in the restaurant industry.
However, you could argue that McDonald's over the past few years has become out of touch with its customers. Its menu is simply too large, its drive-thru lines are taking longer to get through, competition is building from the likes of fast-casual eateries such as Chipotle Mexican Grill, and consumers are craving healthier food options. These developments have made McDonald's sluggish growth rate very unappealing for investors.
So which side is right? Over the long run I believe McDonald's brand power and innovation will pay off, but I don't believe this will be a quick turnaround. Negative PR and a clunky menu aren't problems that disappear overnight. McDonald's new advertising campaign could help its image problem, but it will need a menu overhaul to enact significant long-term change and instill brand loyalty with consumers. While 15% upside appears achievable in the future, I see no rush to jump into McDonald's stock here.
Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.
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