Despite headwinds, as of mid-2024, McDonald's Corp. (MCD, Financial) still remains a potent force in the fast-food landscape.

Nonetheless, the sentiment surrounding the stock has soured over the past six months on the back of economic and geopolitical challenges. As a result, same-store sales growth has slowed down considerably, impacting the company and its restaurant industry peers.

Making the most of this opportunity, though, McDonald's is looking to reinforce its value proposition and deepen customer engagement. Moreover, its dividend profile remains attractive, and the recent dip makes it an ideal time to snag a top-income stock.

That said, let's delve a little deeper into the McDonald's narrative and explore what makes it a rather compelling bet at current prices.

Revitalizing the value proposition

The fast-food space is under duress due to rising prices and evolving consumer behavior. Same-store sales declined in the first half of the year; however, a stabilization trend is in play with disposable incomes on the rise and spending on food away from home normalizing. That said, McDonald's is making the most out of the situation with its innovative moves, including it $5 value meal offerings, to kick start a potential rebound.

From its humble beginnings, McDonald's has been known for its straightforward and wallet-friendly menu. However, since the early 2000s, the company has transitioned toward a diverse and quality-focused menu backed by savvy tech enhancements such as digital kiosks and mobile ordering. Though that strategy paid many dividends, the current economic and political challenges necessitated a pivot.

The uncertain economic climate and rising operational costs affected the company's margins. This is shown by a year-over-year drop of 439 basis points, with the chain's second-quarter 2024 performance dipping to 31.20%. Moreover, there's been a slight year-over-year dip of 0.24% in its gross margin, which now stands at 57.29%.

Emphasizing these shortcomings, CEO Chris Kempczinski pointed to several factors, including California's recent minimum wage hike, sparking wage inflation across the country. Compounding these woes is a decade-long trend of upwards of a 100% increase in menu prices. However, to counterbalance rising costs and win over price-sensitive customers again, the fast-food giant introduced its $5 meal deal. Though its impact has not been absorbed in its quarterly results, the preliminary results show it positively impacted U.S. visits, particularly low-income diners.

According to data from Placer.ai, foot traffic began rising in the latter half of May, driven by the anticipation of the deal, and continued to rise following its official launch on June 25. Additionally, diners earning less than $40,000 annually substantially increased their visits in May and June. Kempczinski also emphasized during the company's second-quarter earnings call that the promotion met its goals while having a meaningful impact on
lower-income cohorts.

Exploring current fundamentals and potential upside

McDonald's challenges are reflected in its underperformance across multiple key metrics over the past three quarters. Revenue missed estimates in two out of the past three quarters, with the biggest miss coming in its most recent second-quarter showing. Similarly, its earnings per share missed estimates in each of the past three quarters, with an 8.97% coming in the second quarter. Similarly, operating cash flow per share has consistently underperformed, missing expectations by 1.50% and 37.46% in the last two quarters, underscoring its struggles in cash generation.

Much of the gloom surrounding McDonald's stock during the first half of 2024 has to do with its forgettable second-quarter showing. The three-month period was marked by a 0.70% drop in same-store sales, which was its first drop in U.S. same-store sales over the past 16 quarters. Moreover, despite the resilience in digital engagement, with $7 billion in loyalty member and delivery sales, overall performances were weighed down by weak results
globally. Sales dipped in established markets such as France, and growth markets were sluggish due to geopolitical tensions in the Middle East and China.

However, forward-looking estimates suggest its second-quarter performance is a temporary roadblock on an otherwise promising trajectory.

Based on the 2023 sales of roughly $25.75 billion, analysts forecast a relatively modest 1% increase compared to the 2024 median estimate of $26.06 billion. The forecast is significantly behind McDonald's five-year average revenue growth of 3.65%. However, it is expected to pick up the pace in 2025, with a median estimate of $27.34 billion, beating 2024 median estimates by more than 4.50%. By 2026, the trend is expected to accelerate, with median sales expected to rise to $28.88 billion, translating into more than 5% from 2025.

The trend is similar to McDonald's forward earnings per share projections, which point to a robust upward trajectory. Based on median estimates, its earnings are expected to jump from $11.61 in 2024 to $13.81 by 2026. Given last year's earnings of $11.63, the 2026 estimate suggests a 24.20% rise.

Further, a look at McDonald's profitability metrics demonstrates a strong financial position, alleviating concerns over its recent underperformance. It boasts a robust gross margin of 56.97% and an impressive operating margin of 45.66%, which are virtually in line with its historical numbers. Its net margin is at a healthy 32.25%, ranked higher than 98% of companies in its niche, underscoring its efficient cost management and pricing strategies. Additionally, its three-year return on invested capital of 227.9% indicates its incredible showing in capital efficiency. With 10 consecutive years of profitability, McDonald's demonstrates a resilient and sustainable financial performance, laying concerns to rest over its long-term viability.

Since 2020, McDonald's ROIC relative to its weighted average cost of capital has been on an uptrend. The ROIC to WACC spread rose from lows of 7% in 2020 to approximately 12% in the most recent year. This increase shows that McDonald's is generating significantly higher returns on its invested capital compared to its cost of capital.

Assessing market value and dividend strength

Looking beyond McDonald's core financials, it's hard to overlook its outstanding dividend profile.

With a forward yield exceeding 2.31%, it has paid a consistently growing dividend over the past 22 years, maintaining a healthy 55.29% payout ratio. With room for further dividend growth, McDonald's is on track to potentially earn a spot in the Dividend Aristocrats club within the next three years. Additionally, with a payout ratio lower than 60%, the company has sufficient earnings to continue paying dividends while reinvesting in its business. Moreover, with all the hullabaloo surrounding its top-line performance, the company recently announced a healthy quarterly cash dividend of $1.67 per share.

The chart above shows McDonald's steady growth in earnings per share, dividends per share and free cash flow per share over the years. We can see that its earnings and free cash flow have risen at a rapid pace, pointing to its strong bottom line and cash generation.

Additionally, the dividend per share has consistently risen, reflecting McDonald's commitment to returning value to shareholders. Notably, the FCF line remains above dividends per share, suggesting dividends are well-covered by cash flows. On top of that, the chart emphasizes the consistent alignment between earnings and dividends, reflecting a robust balance between earnings and dividend payouts. This suggests a well-rounded strategy for both business expansion and shareholder returns.

What truly sets it apart among income stocks is its combination of a growing dividend and impressive share price gains. The chart above shows the performance of McDonald's stock compared to its peers and the U.S. core consumer price index over the past decade. The company has achieved a remarkable 211.1% growth, comfortably outperforming the CPI, which rose by 33.30%. This impressive performance demonstrates the fast-food giant's ability to navigate inflationary pressures and deliver substantial returns for its investors.

Further, McDonald's recent performance points to a bullish trend, with its price rising steadily since mid-June 2024. The stock has risen above all key moving averages, indicating powerful upward momentum. Particularly, its five-day moving average is positioned above the stock price, underscoring the potential for continued short-term bullishness. I would not be surprised to see the stock surpass its 52-week high of $302.39, potentially aligning closely with its GF Value of $313.39.

Final word

McDonald's has had its fair share of troubles in the past year, but this reflection period could be a blessing in disguise. As part of a broader effort to grow affordability and appeal to cost-conscious consumers, the company has proven proactive in the current turbulent economic landscape.

Moreover, the stock is still trading at a considerable discount based on forward estimates. If it can dish out a few earnings surprises in the coming quarters, we could see it march towards even greater heights. Hence, with an eye on both immediate impacts and long-term strategies, the fast-food giant continues to refine its approach while maintaining its market stronghold and delivering value to customers and investors alike.