Guggenheim upgrades McDonald's, says restaurant revamp will send stock to $200 next year

  • Analyst Matthew DiFrisco upgrades McDonald's to a buy rating from neutral and issues a $200 price target, implying a 17.8 percent upside over the next year.
  • "The modernization efforts are designed to drive incremental customer visits and higher average check," the analyst says. These investments should "help further McDonald's global leadership atop the fast food category as digital mobile ordering continues to redefine convenience and personalization for the consumer."
An employee brings an order to customers at the restaurant inside the new McDonald's Corp. headquarters in Chicago, Illinois, U.S., on Monday, June 4, 2018. 
Joshua Lott | Bloomberg | Getty Images
An employee brings an order to customers at the restaurant inside the new McDonald's Corp. headquarters in Chicago, Illinois, U.S., on Monday, June 4, 2018. 

Investors should buy McDonald's stock as its restaurant revamp becomes a tailwind as early as the second half of next year, Guggenheim says.

Analyst Matthew DiFrisco upgraded McDonald's to a buy rating from neutral and issued a $200 price target, implying a 17.8 percent upside over the next year. McDonald's shares fell 0.9 percent amid a steep market sell-off.

The fast-food giant has been undergoing a redesign of its restaurants in the past year, including installing kiosks where customers can order and adding table service. The so-called Experience of the Future (EOTF) revamp aims at "elevating the consumer experience," according to the company, but DiFrisco says it has been a drag on same-store sales. This headwind should reverse in 2019 and become a tailwind for McDonald's, DiFrisco said.

"The modernization efforts are designed to drive incremental customer visits and higher average check," DiFrisco said in a note Tuesday. "The shared EOTF investment with franchisees should help further McDonald's global leadership atop the fast food category as digital mobile ordering continues to redefine convenience and personalization for the consumer."

By the end of the second quarter, more than 4,000 of the approximately 14,000 U.S. restaurants were fully converted or had elements of it, DiFrisco said. The company also said in June it will add self-order kiosks to 1,000 stores each quarter.

Sales for stores that are fully upgraded are within management's range, while those with partial upgrades experience a 1-to-2 percent lift in sales, the analyst said. However, stores must close for a period of time as the upgrades are installed, hence creating the initial drag in same-store sales. "Stores tend to require a period of time (up to a month) to return to normal sales levels as customers need time to recognize the store has reopened," DiFrisco said.

DiFrisco added that McDonald's shares should get a boost because the company's valuation relative to its peers is unjustifiably low, given the expected tailwind from the store upgrades.

The analyst said McDonald's is trading at 15.6 times enterprise value to earnings before interest, tax, depreciation and amortization, 33 percent and 21 percent below that of Domino's Pizza and Yum Brands. "We see valuation upside to shares in MCD by simply applying a reversion back to its historical discount to peers," he said.

McDonald's shares were down 1.3 percent year to date through Tuesday's close, lagging the broader market and its peers. The S&P 500 is up 7.7 percent in 2018, while Domino's and Yum Brands are up 50.4 percent and 11.7 percent, respectively.

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