McDonalds (MCD) is set to report earnings Tuesday morning before the bell, and I think the fast-food operator is setting up as a buying opportunity.

MCD’s has done a great job over the past few years of improving its food, streamlining ordering and generally improving the feel of its stores.

In 2015, when Steve Easterbrook took the helm as the President and CEO of MCD, he initiated many transformational plans.  One of which was to ‘re-franchise’ the stores.

The goal was for McDonald’s as a corporation to become ‘asset’ light while still retaining tight controls over operations, such as how and what is served, and benefiting from fees, higher margins and increased cash flow — all things that shareholders of public companies love.

And while no-one can dispute Easterbrook’s changes from all-day breakfast, simplified-yet-better menu offerings, to investment in technology and remodeling the stores have all been smart and improved sales and profits, the changes did not come without challenges.

It’s estimated to cost from $200,000-$500,000 per location to bring the stores up to corporate code. This includes remodeling and refurbishing, new kitchen equipment and new technologies such as kiosks and integrating mobile apps.

While corporate can contribute as much as 50% of these costs, the capital outlay for franchisees who often own five or more locations can run into the millions of dollars.

Couple this with an emphasis on value or $1 money promotions, which do drive traffic, but come with lower margins and franchisees were feeling squeezed.

McDonald’s management claimed it needed to continue investing technology and store upgrades to keep growth positive in an increasingly competitive quick-serve industry.

Unlike other national chains, such as Wendy’s (WEN),  MCD franchisees don’t have an independent representative committee.  Instead, a group of franchisees formed an advocacy group that sent a letter and made plans to meet with corporate executives in Tampa in 2017.

Their goal was to push the company to help improve profit and cash flow at their restaurants.

This tension came to a near breaking point in early 2018 when the company posted disappointing earnings and same-store sales increases, most recently 2.4%, the slowest rate in over two years.

As you can see, it suffered over the next few months before gaining its footing and beginning a fairly steady march to a series of new all-time highs through most of 2019.

(Source: StockCharts.com)

At this point, the company is now running as a well-oiled machine, the margin killing $1 menu has mostly been eliminated and strategic roll-out of old favorites such as the McRib or new Beyond Meat  (BYND) burgers keep interest fresh.

The company has beat estimates 11 of the last 12 quarters and current eps have been reduced from $2.26 to $2.21 over the past few weeks setting up a lower bar.

(Source: Earnings.com)

Now with the stock having pulled back some 5% over the past few weeks and sitting on support around the $208-$210 level, it sets up for a renewed run on a good earnings report.

I’m buying call spreads to establish a bullish position heading into the earnings report.

MCD shares were trading at $210.23 per share on Monday afternoon, up $1.73 (+0.83%). Year-to-date, MCD has gained 20.48%, versus a 21.56% rise in the benchmark S&P 500 index during the same period.

About the Author: Option Sensei

Steve has more than 30 years of investment experience with an expertise in options trading. He’s written for TheStreet.com, Minyanville and currently for Option Sensei. Learn more about Steve’s background, along with links to his most recent articles. More...

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