Argus Downgrades McDonalds To Hold Citing Rising Labor Costs & Slowing Comp Sales

Although McDonald's Corporation MCD reported strong 2Q16 earnings, its overall revenue and SSS were short of expectations. The company is likely to face pressure from decelerating comp-store sales growth and rising labor costs over the next several quarters, Argus’s John Staszak said in a report. He downgraded the rating on the company from Buy to Hold.

McDonald’s reported its 2Q16 operating EPS at $1.45, ahead of the consensus estimate of $1.39. The beat was driven by higher restaurant margins and share buybacks. The company’s revenue came in at $6.3 billion, down 4 percent y/y, and marginally below the consensus estimate. Although overall SSS were up 3.1 percent, they missed the consensus forecast of 3.6 percent growth.

Concerns

Management indicated a widening gap in the prices of restaurant food and food at home. This could continue to adversely impact restaurant traffic and comp sales, Staszak noted.

The EPS estimates for 2016 and 2017 have been reduced from $5.60 to $5.50 and from $6.30 to $6.20, respectively, reflecting prospects for higher labor costs and slower growth in comp-store sales, the analyst mentioned.

Valuation

McDonald’s shares are currently trading close to their five-year peak. At a relatively high valuation, the share price adequately reflects the benefits from management’s turnaround plan. “Based on our expectations for rising labor costs and slower growth in same-store sales, offset in part by gains from restaurant refranchising, we expect limited share price appreciation over the next 12 months,” Staszak commented.

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