McDonald's (MCD, Financial) stock has been rock-solid over the past few months of choppy market moves. Though shares aren't undervalued relative to the stock's historical average multiples, I think the stability is worth paying a premium multiple for. McDonald's may be able to continue to command a higher premium as the rate-hike turbulence returns to Wall Street.
Undoubtedly, the Federal Reserve's latest rate hike and less-than-hawkish commentary didn't deliver too much in the way of surprises. Still, the markets surged intraday, only to nosedive into the close. I would have expected a smaller (25 basis points) hike alongside somewhat comforting commentary (a rate pause coming soon?) to have induced a sustained move in the S&P 500 to higher levels. As markets dissect the Federal Reserve's latest game plan, I can't help but dread the next round of economic data reports, as the market's continued weakness could be indicative of the underlying economy.
Inflation has been lingering for far too long, and it could hang around for much longer as the pace of rate hikes grinds to some sort of slowdown. For now, rate cuts in 2023 seem like wishful thinking. The Fed noted that "rate cuts are not in our base case." As investors reset their rate expectations, it's hard to imagine the rest of the year being any less rocky. Rough waves ahead mean investors should brace their portfolios for spikes and plunges.
At this juncture, McDonald's is one of my favorite stability plays. Though shares aren't as undervalued as McDonald's menu items, I think the price could still go up as inflation weighs on customers' wallets and prompts them to take their business from more expensive restaurants to cheaper ones. Thus, bear market or not, McDonald's growth may be minimally impacted by recession or rate headwinds ahead.
Valuation and dividend
At the time of writing, McDonald's stock trades for a price-earnings ratio of 32.2, which is relatively high, even for such a high-quality company. Even the most secure, recession-resilient company on the planet can be a very risky bet if you pay too much. However, I do not view McDonald's as overpriced considering its role as a "volatility shelter" and the growth prospects the company can embrace due to inflation.
McDonald's isn't the same as it was more than a decade ago, which is good because stagnant players get left behind in a changing market. The company has continuously reinvented itself with the help of tech and creativity. With one of the best mobile apps (in my humble opinion) and promotion deals with several profoundly influential celebrities (such as BTS and Mariah Carey), it's clear that McDonald's is willing to try new things to reclaim some of the market share that rivals have nibbled away at.
If you're one of the many BTS fans out there, things like the BTS meal are a must-buy, even if they aren't all too different from McDonald's other menu offerings. More importantly, such celebrity meals will also leave a good, possibly long-lasting impression on fans. Thus, I believe this is a great strategy.
Looking ahead, McDonald's trades for a forward price-earnngs ratio just north of 25. That's a palatable multiple that factors in the company's ability to keep flexing its muscles in a challenging year for broader markets.
The forward dividend yield is currently at 2.25%, which aligns with the restaurant industry average. The payout may not be bountiful, but it seems safe and could benefit from growth from here. Over the past five years, McDonald's has averaged 8% annual growth in dividends as of the end of 2022. Even if we're in for a hard landing for the economy, I expect the dividend growth rate to remain consistent as the company looks to keep the growth alive.
Over the last three years, the fast food giant has averaged 5.2% in operating income growth. Inflation's impact has led many consumers to go for lower-cost food options, helping McDonald's fight inflation. Regarding value menus, McDonald's is still one of the kings. Even as the company continues to raise prices, I see few that can maintain such a mouth-watering value for consumers. Further, the mobile app, which features coupons and offers, may continue to enjoy growth as more people look for added savings.
A good place to be in a recession
Harsh economic conditions could work out in McDonald's favor. After all, McDonald's is built to thrive when times get tough and everything else takes a dive.
Unlike back in 2008, McDonald's now has more tools (and tech like mobile apps) it can leverage to help keep value-hungry consumers coming back consistently, even once the economy heals and the appetite for cheap food falls.
Will customers keep eating at McDonald's when their budgets allow them to splurge on fancier dine-in options? They likely will, but perhaps at a lower rate. If McDonald's plays its cards right and keeps its customers engaged, I'd say there's a good chance that it can keep hungry customers coming back even when times are good.
Of late, the golden arches deserve a gold star for menu experimentation. The Chicken Big Mac, McCrispy and other new items create another reason to head down to the local McDonald's or order some McDelivery.
More recently, the company expanded its partnership with Oatly (OTLY, Financial) in the Austrian region. With Beyond Meat (BYND, Financial) as a potential heavy hitter to include in future menu staples, there are many roads that McDonald's can travel down to stay popular with consumers.
Final thoughts
Simply put, McDonald's has a decent chance to continue growing in a recession, even as most other fast food chains witness their earnings shrink at the hands of an inflation-ravaged economy.
Just because McDonald's has been a solid rock amid inflation doesn't mean it isn't also feeling the pinch. Fortunately, McDonald's can still raise prices to offset lingering inflation pressures without losing customers. At the end of the day, many loyal McDonald's customers know they're getting tremendous value on a relative basis.
