Company Reports

As we gear up for the release of first-quarter earnings, our top picks in the restaurant industry remain wide-moat McDonald's and wide-moat Starbucks, trading at 14% and 19% discounts to our $312 and $105 fair value estimates, respectively. While industry traffic has been depressed for two years, both brands boast strong digital platforms that allow them to defend transaction frequency without indiscriminate national discounting, and both benefit from scale-driven cost advantages that should allow them to meet the needs of the increasingly value-sensitive consumer without sacrificing financial performance. These are the two most important factors, in our view, that will distinguish the best and worst performers in our industry coverage over the coming years. The industry looks fairly priced in aggregate, trading at a 3% premium to our market-cap weighted fair value estimates. The aggregate figure masks a very bimodal return distribution: Brands like narrow-moat Wingstop (up 108% annually) and wide-moat Chipotle (74%)—which boast strong unit economics and have taken material industry transaction share—have materially outperformed brands like no-moat Wendy's (down 9%) and narrow-moat Papa John's (down 17%), which have not. Those top-performing brands are fully priced, trading at material premiums to our intrinsic valuation (163% and 52%, respectively), suggestive of meaningful execution risk.

McDonald's' strategy, as laid out at its most recent investor day in December 2023, emphasizes its competitive strengths through an "MCD" framework: relevant marketing, core menu development, and the four Ds: digital, drive-thru, delivery, and development. The firm's approach strikes us as cogent, and appears to be meeting the evolving needs of today's restaurant consumer.

While wide-moat McDonald's slightly missed our earnings expectations across the board during its fourth quarter of 2023, we continue to believe the firm is arguably the best positioned in our global coverage to benefit from restaurant digitization, particularly through its loyalty program, and an ongoing global mix-shift toward chained restaurant brands. Investors should capitalize on an opportunity to load up on shares at a slight discount after a 3%-4% pullback in intraday trading, leaving the firm trading at about an 8% discount to our $310 intrinsic valuation, which we expect to leave largely unchanged.

As we survey the U.S. restaurant landscape looking toward 2024, the largest, chained restaurants with durable cost advantages look best positioned to outperform. We expect industry growth to remain low—just 1.3% annually in real terms through 2025, versus a long-term average of 2.5%. The sharp slowdown is predominantly attributable to slowing consumption spending, with pressured U.S. consumers already limiting restaurants’ ability to further increase prices and likely driving an uptick in industry promotional activity.

McDonald's' strategy, as laid out at its most recent investor day in December 2023, emphasizes its competitive strengths through an "MCD" framework: relevant marketing, core menu development, and the four Ds: digital, drive-thru, delivery, and development. The firm's approach strikes us as cogent, and appears to be meeting the evolving needs of today's restaurant consumer.

Wide-moat McDonald's investor day left us impressed, with color regarding the firm's loyalty program opportunities, aggressive development targets, and investments in rationalizing redundant expenditures across its global technology stack seeming like investments poised to unlock substantial value for the world's largest restaurant brand. We plan to raise our $290 fair value estimate by a high-single-digit percentage, attributable to loyalty-enabled comparable store sales increases (3%-4% valuation impact), better-than-expected unit growth (4%), and time value (1%).

As the leader in global food-service sales, McDonald's is taking adequate steps to adjust to an evolving competitive landscape, in our view, leveraging its scale to invest heavily in digital capabilities and menu innovation as it leans into its MCD strategic framework. While we expect a turbulent couple of quarters amid a soft macroeconomic environment, we're encouraged by management's vision for the business, which we believe should enable McDonald's to maintain its edge.

Wide-moat McDonald's continues to prove resilient despite widespread consumer pressure, with its strong value positioning, investments in core menu development, and digital acuity driving another quarter of healthy top-line performance. The firm's $6.69 billion in sales and $3.17 in diluted EPS comfortably edged our respective $6.29 billion and $2.70 EPS estimates, with nearly 9% global comparable store sales growth attesting to broad-based strength across the firm's 115-plus global markets. While results comfortably exceeded our quarterly forecasts, we expect to increase our $285 intrinsic valuation by just a low-single-digit percentage as we balance strong results, time value, and worse-than-expected traffic (slightly negative). More concretely, we expect to pull down our 2024 comparable store sales estimates by a couple of points across regions as the competitive environment intensifies, with competition for the breakfast daypart—roughly 25% of McDonald's sales—and for lower-income clientele remaining intense. Shares strike us as attractive.

The restaurant industry looks cheap to us for the first time since fall 2022, with the recent market correction creating a buying opportunity for long-term investors. Our coverage trades at a 7% cap-weighted discount to our intrinsic valuations, with wide-moat companies like Yum Brands, Starbucks, and McDonald's looking unusually alluring, each trading at a 10%-12% discount to our respective $139, $103, and $285 fair value estimates. We recognize that slowing same-store sales pose a near-term risk, but believe that large, quick-service operators with scale-driven cost advantages and strong digital touchpoints look poised to capture market share in this dynamic environment. Restaurants are more resilient than many investors realize, with companies that outperform on the basis of "value for the money" like McDonald's and wide-moat Chipotle even posting comparable-store sales growth over the course of the 2007-09 downturn. While we expect consumer spending to slow in 2024, we continue to maintain that the U.S. will avoid an outright recession and believe that investors seeking consumer cyclical exposure would do well to consider turning toward the restaurant industry at current prices.

As the leader in global food-service sales, McDonald's is taking adequate steps to adjust to an evolving competitive landscape, in our view, leveraging its scale to invest heavily in digital capabilities and menu innovation as it leans into its MCD strategic framework. While we expect a turbulent couple of quarters amid a soft macroeconomic environment, we're encouraged by management's vision for the business, which we believe should enable McDonald's to maintain its edge.

As the leader in global food-service sales, McDonald's is taking adequate steps to adjust to an evolving competitive landscape, in our view, leveraging its scale to invest heavily in digital capabilities and menu innovation as it leans into its MCD strategic framework. While we expect a turbulent couple of quarters amid a soft macroeconomic environment, we're encouraged by management's vision for the business, which we believe should enable McDonald's to maintain its edge.

Wide-moat McDonald’s continues to fire on all cylinders, with $3.17 in adjusted diluted EPS and $6.5 billion in sales blowing past our $2.67 and $6.4 billion estimates, respectively. While we agree with management that the firm is likely to see macroeconomic pressure drive slowing sales growth over the second half of 2023 (and likely into 2024), we remain impressed with the firm’s ability to balance consumer desire for value, franchisee cash flow, and corporate-level profitability. The burger chain posted double-digit same-store sales growth in all three operating segments, with consolidated global comp growth of 11.7% suggestive of meaningful market share gains. As we digest outsize quarterly earnings and factor in an attractive near-term growth roadmap—driven by the firm’s 52 million global loyalty member base, a quickly swelling digital sales mix, success with core menu innovation, and strong value positioning—we expect to raise our $260 fair value estimate by a high-single-digit percentage, leaving shares looking fairly valued. The lift can be largely attributed to volume-driven operating leverage and an uptick in midterm unit development, catalyzed by positive franchisee cash flow during the quarter despite ongoing inflationary pressure.

Restaurant stocks look expensive as we take the industry's pulse, with names in our coverage trading at a market-cap-weighted 10% premium to our intrinsic valuations. While demand has held up nicely to date, we're seeing weak spots, with persistent declines in traffic and items per check suggesting price-conscious consumers and a more challenging pricing environment to come. Nominal same-store sales growth remains healthy, up around 5.7% industrywide over the past three months (RMS data), but traffic (down 1.4%) and items per check (down 3.7%) remain points of concern. We expect slowing sales momentum into the first half of 2024, resulting in a more promotional environment for the industry and a three- to four-year route to normalized restaurant-level profitability. The industry's bargain bin looks sparse, but we see modest upside in Wendy's and Starbucks shares, which trade at 6% and 2% discounts to our $23 and $104 fair value estimates, respectively.

As the leader in global food-service sales, McDonald's is taking adequate steps to adjust to an evolving competitive landscape, in our view, leveraging its scale to invest heavily in digital acuity and menu innovation en route to compelling unit economics.

We plan to raise our fair value estimate for wide-moat McDonald's by a high-single-digit percentage due to resilient comparable store sales and a near-term uptick in unit growth, but shares continue to look expensive even relative to our revised valuation.

The restaurant industry has proven surprisingly resilient despite stout macroeconomic headwinds, but between normalizing consumer spending patterns, a widening value gap with the grocery channel, and early signs of price sensitivity, we believe that 2023 is shaping up to be challenging. Despite early indications of a strong first quarter, we continue to expect a softer second half of the year, limiting near-term margin recovery as restaurants are reluctant to outprice their core customer. To this effect, traffic and items per check have declined in each of the past 10 months industrywide—through February 2023—and we continue to view exclusively price-driven comparable store sales growth as a tenuous long-term strategy. We sport a carb-heavy value menu in the industry, with wide-moat Domino's and narrow-moat Toast representing our top picks, trading at 16% and 18% discounts to our $397 and $21.50 fair value estimates, respectively.

We believe that prudent adoption of digital ordering, restaurant software, and loyalty programs can yield meaningful benefits for the restaurateurs we cover as well as for astute investors who can identify today's digital leaders. We expect investments in technology to pave the way for food-service establishments to gain share from the grocery channel, settling just north of 55% of U.S. consumer food spending, ahead of our prior 50% estimate, as technology-driven cost savings enable restaurateurs to narrow the value gap with the cheaper grocery channel. The largest chains in our coverage are poised to disproportionately benefit from technology adoption; we forecast their share of total restaurant sales to grow by 200 basis points over the next five years, with wide-moat firms like Chipotle, Starbucks, and Domino's looking particularly well positioned. Investors looking for immediate-term opportunities should consider Domino's and narrow-moat Toast, which trade at roughly 16% and 17% discounts to our $397 and $21.50 intrinsic valuations, though we'd remain eager buyers of leaders like Chipotle and Starbucks at prices below our $1,550 and $103 fair value estimates.

As the leader in global food-service sales, McDonald's is taking adequate steps to adjust to an evolving competitive landscape, in our view, leveraging its scale to invest heavily in digital acuity and menu innovation en route to compelling unit economics.

Wide-moat McDonald's long-term road map is intact, but fourth-quarter results and 2023 guidance suggest a protracted recovery to prepandemic profitability. Diluted earnings per share of $2.59 aligned closely with our $2.60 forecast as strong guest traffic offset softer-than-expected margins. The 14.6% U.S. restaurant margin and 17.4% international operated markets margin were 40 and 160 basis points shy of our forecasts, with management's guidance for midteens European inflation in 2023 adding a degree of near-term earnings risk that we'd underestimated. We now project slightly softer earnings growth in 2023, with a full recovery to prepandemic restaurant margins likely stretching out five or six years (2027) as the firm prices at or below inflation to defend guest traffic gains. We expect to lower our $247 fair value estimate by a low-single-digit percentage, roughly consistent with the market's reaction to earnings.

We expect sluggish sales growth to represent the key issue for the restaurant industry in 2023, following a year of investor concern regarding inflated input costs and margin compression. Though we see modest upside in wide-moat Domino's and view wide-moat Chipotle shares as fairly valued, the industry trades at a 5% market-cap weighted premium to our fair value estimates, suggesting that current entry prices are less than salient.