Why Goldman Sachs Is Adding AutoZone, McDonald's To Its Conviction List

Goldman Sachs' "Conviction List" of stocks that are expected to outperform now includes two new entrants: auto parts retailer AutoZone, Inc. AZO and fast food chain McDonald's Corporation MCD.

The Analyst

Goldman Sachs' Matthew Fassler maintains a Buy rating on AutoZone with an unchanged $780 price target while adding the stock to the Conviction List.

Goldman's Karen Holthouse maintains a Buy rating on McDonald's with a price target lowered from $186 to $185 while adding the stock to the Conviction List.

AutoZone

The auto parts retail sector has undergone a two-year period of "subdued sales" from unusually warm winters, Fassler said in a research report. (See the analyst's track record here.)

A "more normative" winter period in 2017-18 should result in a "solid" summer season, especially when considering winter freezes cause parts failure when the weather warms up, the analyst said. 

Auto parts retailers like AutoZone boast a tailwind for 2019 and beyond, Fassler said: Sales of auto parts correlate well with the population of cars that over 10 years old, and this segment will become evident in 2019 and beyond from the "last stages of the hangover" from the financial 2009 financial crisis.

AutoZone's stock also appears attractive given a "rich" free cash flow yield of 8.5 percent on 2018 estimates and 8.3 percent on 2019 estimates, the analyst said. The stock is trading near the low end of its recent historical relative P/E range.

Related Links: AutoZone Is One Of The Steadiest Performers In Auto-Parts Retail Space

McDonald's

McDonald's stock has underperformed the broader S&P 500 index by 8 percent since the end of 2017, Holthouse said in a note. (See the analyst's track record here.)

This pullback creates an opportunity for investors to buy into a multiyear comp growth story at a time when McDonald's faces a "more fragmented" competitive landscape in which its four biggest competitors account for 16 percent of the market in the U.S. versus a historical average of 24 percent, the analyst said. 

The Golden Arches should show improving margins in the U.S. from three "underappreciated" areas, Holthouse said:

• Falling food inflation.
• The end to "significant" upfront costs related to training for fresh beef and other initiatives.
• An 80-basis point decline in advertising co-op contributions that kicked in Jan. 1. 

McDonald's stock is now trading at a valuation of just 1.2x the S&P 500's P/E multiple, which is back in-line with the five-year average — but also comes at a time when investors have high visibility into high-single digit EPS growth, as it is near its 93-percent franchise target, Holthouse said. 

Price Action

Shares of AutoZone were trading lower by 0.41 percent Monday afternoon, while McDonald's stock was nearly flat. 

Related Link:

McDonald's: Buy The Pullback, Says BMO

Photo by AntonioMartin/Wikimedia.