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McDonald's Turnaround Gains Traction

We’re modestly raising our fair value estimate after the restaurant giant reported better-than-expected U.S. sales and showed signs it is overcoming its execution issues, writes Morningstar’s R.J. Hottovy.

The clear highlight of

The key question now becomes whether U.S. sales trends are sustainable beyond the fourth quarter, which is when management forecasts positive comps across all regions, and we believe they are. First, U.S. sales weren't a function of a single product (though the Premium Buttermilk Crispy Chicken Sandwich was a standout), but rather a combination of recipe changes using higher-quality ingredients and incremental labor investments and training (improving speed of service and order accuracy). Additionally, while all-day breakfast in the U.S. should be a positive for fourth-quarter traffic, we believe the more important takeaway is that the program went from a single test market in May to nationwide in October. This implies McDonald's is overcoming its recent supply chain and execution issues and portends a more seamless rollout for new products. Lastly, we're encouraged by international lead segment comps of 4.6%, and believe innovations in these regions (including Experience of the Future features and value-menu innovations) can serve as a blueprint for more sustainable U.S. growth.

We're raising our fair value estimate to $110 from $105 based on a modest increase in our near-term revenue--including 2%-3% comps in the U.S. in 2016--offset by slightly higher labor investments than initially assumed (through we still project operating margins between 27% and 28% this year). We find shares fairly valued but wouldn't require much margin of safety given McDonald's still-strong competitive position and operational improvements.

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