This Restaurant Stock is Looking Tasty
Andrés is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Investors in McDonald's (NYSE: MCD) have received some lackluster returns lately, and their happy meal is not looking as joyful as it used to. McDonald's has been a strong performer in the long term, even during the worse times of the last recession, so there are some valid reasons to wonder if this is an opportunity to buy shares of this global powerhouse at discounted prices. In spite of some short term headwinds, McDonald's looks like a tasty idea for those looking to buy a solid company with strong fundamentals at a convenient entry point.
It’s all a matter of perspective and timeframes after all; McDonald´s has shown very different performance depending on the time period under analysis. Shares of the fast food giant have done much worse than the S&P Depository Receipts (NYSEMKT:SPY) ETF, which tracks the S&P 500 index, over the last six months. Taking a longer term look, however, things are quite different, and McDonald's has delivered outstanding returns over the last five years, both in absolute terms and in comparison to the major indexes.
The company has seen some weakness in earnings recently, with sales and margins under pressure due to uninspiring economic growth around the world as well as higher expenses because of rising commodities prices. Although these factors could continue weighing on the company in the middle term, McDonald´s has already proven to investors that it can deliver strong results even under considerably harder conditions.
McDonald´s operates nearly 80% of its business via its franchise and affiliate system, which provides rents and royalties with minimal capital expenditures during challenging economic times. This produces stability and resiliency for the company´s cash flows when facing tricky economic scenarios. Perhaps due to this underlying strength, McDonald´s has been able to increase its dividends in each of the last 35 years, in spite of recessions and all kind of economic difficulties.
Competition is hard in the fast food industry; and new alternatives are demonstrating competitive strength in the business. Chipotle Mexican Grill (NYSE: CMG) has achieved an almost 40% annual growth rate in earnings per share over the last five years with its superior quality ingredients and deep focus on ecological and sustainability standards.
Achieving double digits growth in same store sales, Chipotle has shown that customers are willing to pay some extra money for their meals if they can get better quality and healthier products, so McDonald´s needs to pay attention to this emerging trend.
The company has made some successful moves with premium products and healthier alternatives like fruit and salads, but it would be very complicated for McDonald´s to compete against smaller companies when it comes to fresh, locally sourced, products. Widening its offering of healthy products is certainly a step in the right direction for McDonald´s when trying to adapt to changing consumer habits, but the Big Mac emporium will not reverse its image as a place for gluttony anytime soon.
Coffee is an interesting area of growth for the company in the middle term. McDonald´s owns many of the most valuable locations around the planet, and management has been smart in leveraging that presence to compete against Starbucks (NASDAQ: SBUX) in the specialized coffee business.
McDonald´s has positioned itself as a cheaper alternative to Starbucks, appealing to value conscious customers who prefer saving a few bucks instead of going for the premium experience offered by Starbucks. Due to its gigantic geographic presence all over the world, McDonald´s has become one of the biggest threats for Starbucks on a global scale, while at the same time the company has introduced new high margin products to its offering.
China is another opportunity for growth in the following years. McDonald´s has lost its leadership position in the country versus Yum! Brands (NYSE: YUM), as the owner of KFC, Pizza Hut, and Taco Bell among others has been investing heavily and achieving extraordinary growth rates in China for the last years. But McDonald´s has done better than Yum! in the rest of the world, so the company has the brand strength and financial resources to step up its growth in China over the next years. If Yum is growing nicely in China, there is no reason for McDonald´s to be left behind.
Shares of this global fast food powerhouse are yielding 3.2% in dividends, and the stock trades at a moderate P/E ratio of 16.5, which compares favorably to the average P/E ratio in the 20 zone that McDonald´s has carried over the last five years.
The company has not lost any of its fundamental attributes; it still has one of the strongest brands in the world, an unparalleled geographic presence and rock solid cash flow generation capabilities. With history as a guide, the recent weakness in price of McDonald´s shares looks like a buying opportunity for long term investors looking for strong dividend plays in the consumer sector.
acardenal has no positions in the stocks mentioned above. The Motley Fool owns shares of Chipotle Mexican Grill, McDonald's, and Starbucks. Motley Fool newsletter services recommend Chipotle Mexican Grill, McDonald's, Starbucks, and Yum! Brands. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.