Avoid The Golden Arches: No Gold To Be Found

McDonald's Corp (MCD) looks overvalued at these levels. The stock is a good short sell candidate.

Investors or traders comfortable with options exposure may consider selling call spreads to take advantage of elevated stock price levels.

On a fundamental basis, MCD has been on a strong run and additional outperformance is unlikely.

The stock price of McDonald's Corp (MCD) is up 20% so far in 2019. Yielding just over 2%, the company's dividend payments are not a strong reason to include MCD as a holding in even a yield-oriented portfolio. Investors should consider MCD overvalued at today's levels above $210/share and evaluate MCD common equity as a short sell candidate.

Fundamentally Overvalued

On a fundamental basis, MCD has been on a strong run and additional outperformance is unlikely. With a market capitalization over $160 billion, MCD sits at all-time record highs. The stock is valued at nearly 30x earnings and nearly 8x sales. Shockingly, MCD trades at 37x its 2018 free cash flow of $4.4 billion; a primary reason investors should consider it fully valued and unlikely to perform as positively in the second half of 2019 as it did in the first.

In addition, management and insiders have continued to treat the elevated stock levels as a way to cash in on their own holdings, with only insider selling in recent periods and no sign of insider buying. This is also not a bullish sign on the future prospects of MCD for potential long equity investors.

Corporate developments and press releases over the last quarters have primarily been business as usual at this mature, execution-oriented corporate franchisor. After some controversy in recent years around the quality of ingredients, the company took customer feedback and has been making a concerted PR push toward demonstrating its "fresh beef" and commitment to source 100% cage-free eggs; it remains unclear how much of the increased resultant cost can be successfully passed through to the average MCD customer by raising menu prices.

Risks

As with any short position, M&A or the prospect of an acquisition or takeover poses a risk. However, this is unlikely as any buyer or prospective acquirer would need to pay a control premium to MCD shareholders, and at the current 37x free cash flow implying a market capitalization of over $160 billion, a premium would make a takeover incredibly unlikely.

Risk of further strong execution and growth also exists, but this is mitigated by the likelihood that such an outcome is perfectly priced into the stock as it sits at today's all-time highs.

Competitive risk from other, smaller burger-focused quick-serve restaurants such as Restaurant Brands International (QSR) and YUM! Brands (NYSE:YUM) does exist as well. These companies are faster growing and may merit the higher growth multiples at which they are currently trading. At $34 and $18 billion of market cap, respectively, these companies offer dividends as well and are trading at lower earnings multiples than MCD. With much more runway for growth, these companies' current valuation is much more justified than MCD's. While execution and other risks may be higher, and while the brand value is certainly lower for these companies than for MCD, there may be more "bang for an investor's buck" evaluating investment opportunities in QSR and YUM.

As uncertainty over interest rates in the broader market prevails, there may some bid to "safe" equity names such as MCD, especially given its strong dividend history for income seeking investors. This may cause the share price to appreciate even further past its overvalued levels of today, but I believe this risk is mitigated by time horizon of this investment; as the interest rate cycle normalizes, the flow-oriented bid in MCD stock will likely subside as well. Thus, investors following this bearish recommendation should be prepared to withstand some potential volatility or unfavorable position moves against them in the short term.

Conclusion

Investors should consider MCD equity overvalued and should reduce or eliminate any long holdings. Yield-oriented investors should consider reducing as well and re-allocating to potentially higher-yielding names. Those comfortable with options should consider utilizing put options or short call spreads to express a neutral-to-bearish view. Good luck.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a short position in MCD over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.