Restaurant Stocks Sell Off After McDonald's Earnings

Dow component McDonald's Corporation (MCD) led a slate of restaurant earnings and analyst calls on Tuesday morning, triggering modest sell-the-news reactions. The group has shaken off 2017 worries that higher commodity prices would affect margins, riding the wave of strong U.S. economic growth and overseas opportunities. Even so, performance has now bifurcated into winners and losers, with giant chains prospering while mid-size and smaller franchises, including Jack in the Box Inc. (JACK) and Sonic Corp. (SONC), have been sold aggressively.

Mickey D's beat fourth quarter EPS and revenue estimates by a wide margin, also reporting that quarterly comps increased by a healthy 5.5%. The stock fell more than a point after the news, suggesting a vanishing pool of available capital on the sidelines following months of higher prices. However, the State of the Union address and Federal Reserve rate decision may be distorting order flow, and it could take several sessions to gauge the market's true reaction. (See also: McDonald's Earnings: Same-Store Sales Will Be Key.)

McDonald's stock has been on a tear since breaking out above May 2016 resistance at $132 in April 2017, posting a high-volume breakaway gap and adding more than 45 points in a powerful uptrend that has held above the 50-day exponential moving average (EMA) for the past four months. It posted an all-time high near $180 just one day before the earnings release, indicating that complacent shareholders were confident that quarterly metrics would not stall or reverse the rally.

Ironically, this superior performance sets the stage for an intermediate correction because price action has generated extremely overbought technical readings that need to be worked off through price and time. The stock has been trading above the 200-day EMA since November 2016, while a single eight-point pullback characterized the sum total of 2017 bear power. This type of upside is unsustainable, raising the odds for a decline as low as $150 some time in 2018. (For more, see: Why Is McDonald's Valued Like a Big Tech Stock?)

Yum! Brands, Inc. (YUM) has matched McDonald's rapid ascent in the past year, lifting to an all-time high. Nomura Securities downgraded the holding company for Pizza Hut, KFC and Taco Bell from "Buy" to "Neutral" just an hour before its rival reported earnings, generating a knee-jerk decline that is testing weekly support in the mid-$80s. Yum! Brands reports earnings on Feb. 8, with mixed action likely between now and then.

The stock topped out in the upper $60s in May 2015 following a multi-year uptrend and sold off to a two-year low in the mid-$40s in the first quarter of 2016. The company spun off China operations through Yum China Holdings, Inc. (YUMC) in November 2016, generating healthy uptrends in both parent and child. Yum! Brands stock broke out above the 2015 high in May 2017 and has gained nearly 30 points since that time. Like McDonald's, the stock looks overbought following its dramatic run, raising the odds that earnings will trigger a sell-the-news reaction.

Chili's parent Brinker International, Inc. (EAT) broke out above the 2007 high in the mid-$30s in 2013 and ended the rally at an all-time high in the mid-$60s in 2015. It then turned sharply lower, entering a multi-legged downtrend that cut through breakout support, dropping to a four-year low in September 2017. A bounce into December reinstated the breakout before pausing in the upper $30s, building a holding pattern through the first month of 2018.

The company beat fiscal second quarter EPS estimates by a wide margin in Tuesday's pre-market release but missed revenues by a small margin. A healthy increase in fiscal year 2018 guidance may keep sellers at bay, supporting a bounce that faces stiff resistance in the mid-$40s. A breakout above that barrier could take months, but strong accumulation since September should allow bulls to complete that task. (For more, see: Here's How Brinker Plans to Turn Chili's Around.)

The Bottom Line

McDonald's reported strong fourth quarter earnings but sold off after the news, suggesting that overbought technical conditions are starting to exert their influence. However, it will take a decline through the 50-day EMA near $172 to overcome the strong fundamentals and signal an intermediate correction. (For additional reading, check out: How to Analyze Restaurant Stocks.)

<Disclosure: The author held no positions in the aforementioned securities at the time of publication.>