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Article / 05 October 2015 at 11:00 GMT

Alpha Picks: McDonald's added to mega cap list despite headwinds

Head of Equity Strategy / Saxo Bank
Denmark
  • McDonald's new CEO is savvy in his choice of recovery weapons
  • Valero Energy looks to gain on domestic refining despite crude's fall
  • Trouble is brewing in Potash after K+S bows out of takeover talks

McDonald's
 The global appetite for Big Macs may be waning but McDonald's should still have a golden future. Pic: iStock

By Peter Garnry

Today we release our bi-weekly top equity alpha picks across the mega, large and mid-cap segments on the US and European equity markets. We present our top 20 picks across each segment. The picks are based on our quantitative equity model utilising several well-known risk factors.

Turnaround on the menu

Steve Easterbrook, the new CEO of McDonald's, is busy these days as he faces multiple headwinds at the world's largest fast-food chain. Sales declined by 9.5% y/y in Q2, driven by a 17.2% drop in its Europe segment as a stronger USD. Global comparable sales decreased by 0.7%, reflecting negative guest traffic in all major segments. The new CEO launched his turnaround plan in May under the title "modern, progressive burger company" highlighting that McDonald's will focus on the burger and change its mix a bit towards being more modern, which in these days means being more healthy.

Despite the regular fancy business school words about being progressive, modern and focus on the burger, more words from management are used on operational growth, comprehensive approach to financial management, improve our efficiency and effectiveness. In other words, management knows that they cannot change the concept quickly enough on products to make results so they engage in classic defensive warfare by cutting cost and creating value through finding operational processes that can be fine-tuned.

McDonald's daily share price in 2015
McDonald's share price in 2015
Source: Saxo Bank

Major headwinds such as a stronger USD, global health trend, fast-food being "even faster"* and more variety of foods appealing to the younger generation. McDonald's has acknowledged this and is driving changes to its product palette and early signs of customer adoption was evident in Q2. However, top line growth is not expected before 2016.

Despite all these issues McDonald's has jumped to being among our top 20 alpha picks among mega cap stocks in the US and Europe. The drivers are strong relative momentum as the stock is up 9.3% year-to-date compared to the S&P 500 which is down 5.2% over the same period. McDonald's also offers high ROIC with a very predictable business model and easy-to-forecast cash flows.

* Chipotle Mexican Grill offers less seating and thus saves more on renting restaurant space

Refining in the US is a good business

The plunge in WTI crude has created a favourable environment for US refiners including Valero Energy which beat the consensus EPS in Q2 by 10% on the back of a strong performance in refining and improved performance in ethanol. 

Valero Energy is also pursuing a shareholder friendly approach, stepping up its shareholder return commitments with the total return of capital (payout) target increased to 75%, encompassing a  higher dividends as well as share buybacks.

The stock is part of our tactical equity portfolio and was one of our best performing positions until  volatility hit the stock market in August (see chart), but the stock has since come back again and we believe investors will continue to reprice it upwards.

Valero Energy daily share price in 2015
Valero Energy share price in 2015
Source: Saxo Bank 

Trouble is brewing in Potash

K+S has had an interesting year so far, if you like volatility, with shares being up as much as 75% at their peak in July as Potash Corp made a very attractive bid for the company. However, most of those gains have now been given back because the merger talks ended and the outlook for potash is quickly deteriorating due to the slowdown in China. As of today, K+S is just 13% ahead YTD.

K+S daily share price in 2015
K+S share price in 2015
Source: Saxo Bank 

– Edited by Clare MacCarthy

 

Peter Garnry is head of equity strategy at Saxo Bank


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Alpha Picks - 2015-10-05

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