McDonald's Benefits From Broad Strength, Elevated Sales

Wide-moat McDonald's MCD reported strong third-quarter earnings, with two-year comparable-store sales of 14.6%, 8.9%, and 4.9% in the firm's U.S., internationally operated markets, and international licensed market segments, respectively--all in excess of our expectations (8.4%, 7.5%, and 0.7%). The firm continues to benefit from strength in its crispy chicken sandwich platform, its Famous Orders marketing campaigns, and incremental purchases driven by the MyMcDonald's rewards program launch. While labor market pressure and supply chain outages pinched results (company-owned restaurant margins dropped 100 basis points sequentially to 19.3%), we're encouraged by the firm's ability to pass through the bulk of costs via 6% menu price increases while carefully evaluating customer receptivity--attesting to the strength of the firm's value proposition. We anticipate a low-single-digit increase to our $234 fair value estimate and view shares as fairly valued. Commodity-cost commentary was intriguing, with guidance of 3.5%-4% for the full year marking a sharp uptick from the 2% of the first three quarters, implying 9% fourth-quarter inflation at the midpoint. While protein price hikes and elevated freight costs have been well publicized, tangled supply chains for kitchen equipment and technology hardware are more salient, given their implications for unit growth. Similar to wide-moat Chipotle, McDonald's management indicated that its pipeline remains robust, but timing is still a factor, and we now anticipate 1.3% unit growth through 2022 before accelerating toward the upper end of management's 2% target in the years immediately following. Consistent with management guidance, our forecast contemplates mid-40% operating margins through 2025 (45.6%), up from 38.1% in 2020, with volume-driven leverage and a mix-shift toward more profitable franchised units representing the key catalysts for margin expansion.

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