McDonald's: Still Attractive For Income Investors

Anjum is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Vietnam is next on the list for McDonald's (NYSE: MCD). With Subway, KFC and Pizza Hut already operating in Vietnam, McDonald’s entry would be an interesting event to watch out for. Let us look at how the company is strategic in its move and what investment positives make it a must in the portfolio.

Innovative McDonald's

The company is innovating, not only its menu, but also its stores, operations and technology. With the restaurant industry growing at a slow rate, innovation is what makes McDonald’s unique and attractive. Ideas for innovation are both borrowed as well as generated on its own. Vast geographical spread has given the company an edge to diversify its ideas.

One such example is borrowing the idea of McCafe and Chicken McBites from its Australian operations. A dinner box multi-person bundled meal has been quite common in Australia since 2010, and the company is considering taking this concept to the U.S, which is the largest market for McDonald's. Over time, the concept of eating together and sharing has become popular both when in a group of friends or with office colleagues. This habit can be capitalized on with the introduction of a dinner box in the U.S and gradually across different markets.

Chef Dan Coudreaut is an executive Chef and director of culinary innovation. He and his team are responsible for brainstorming new menus to impress the taste buds of his customers. While developing a menu, not only the taste, but also its sustainability, depending on the eating habits and continued supply of quality products, is considered. These aspects set McDonald's apart from its competitors.

Further, customers have changed with time. Quality and standards awareness of the food is on the rise. Keeping this in mind, McDonald's has come up with new packaging designs on all carry bags and fountain beverage cups. These packages will provide nutritional information about the food in text and illustrations in an interesting way. All these factors underscore the innovative nature of the company, which will help it grow and sustain.

Entering a new territory

McDonald’s business structure consists of five geographical divisions – United States, Europe, Asia/Pacific/Middle East/ Africa, Latin America and Canada.

However, nearly 75% of the company’s revenue comes from the US, making it the largest market and the key focus for the company. At the same time, expanding into emerging markets to gain market share is also what the company aims to do. This is evident from a recent announcement of the company to start its operations in Vietnam.

Vietnam is the 38th country in Asia that will get to experience McDonald's. GDP growth in Vietnam is expected to be 5.5% in 2013. With higher disposable income, the population is spending more on branded food. Changing eating habits of developing nations is what McDonald's wants to capitalize on. Going forward, the share of revenue from emerging markets is likely to increase gradually and emerging markets will keep top-line growth healthy for the company.

Financials and valuations

Revenue for the company has increased to $6,605 million in the first quarter in spite of a global economic slowdown and the socio-economic situation at China, which has affected most of its competitors. Global comparable store sales for May increased by 2.6% primarily due to an increase in comparable sales across regions.

The company is currently trading at a PE of just 18.7, compared to the industry average of 24.2. The undervaluation compared to its peers seems higher considering an expected earnings growth rate estimate of around 10% in fiscal year 2014 and 11% in fiscal 2015. Besides the growth trajectory, which can fuel stock upside, the company also has an impressive dividend history. The current dividend yield for the company is 3.1%.

McDonald's also paid back $1,126.5 million to its investors in the first quarter in the form of dividends and share repurchases. Even in fiscal 2012, $5.5 billion was returned to its shareholder with $2.9 billion as dividend and $2.6 billion in share repurchases. These facts indicate that the company believes in rewarding its investors.

Competitive analysis

Yum! Brands (NYSE: YUM) has around 4,429 KFC outlets in China with only 918 Pizza Huts casual dining restaurants and 171 Pizza Hut home service outlets. Nearly 50% of the company’s revenue comes from China.

KFC fried chicken outlets are the major revenue generator. But KFC outlet was badly hit when news broke in late December that chickens from two of the company’s supplier have found excessive antibiotic levels. This news has resulted in 7.5% drop in the share price. This was not the end, as the avian flu outbreak in China has further affected the same store sales, which has resulted in 19% decline in revenue from China from a year earlier in May.

Second quarter results have still not been better with sales declining by 12% from a year ago. Same store sales also declined by about 20% with KFC same store sales declining by 26%. Moreover, the stock is trading at more than 23 times its 2013 estimates, which in my opinion is overvalued as the matters discussed above has affected the financials of the company.

On the other hand, Starbucks' (NASDAQ: SBUX) performance in Asia is commendable, as the company has delivered double digit comparable store sales growth for eleven consecutive quarters in China and Asia Pacific region.Comparable store sales growth was 22% and 15% for fiscal 2011 and 2012 respectively. Net revenue from Asia has also increased by 31% in fiscal 2012.

Considering these facts, Starbucks plans to expand its operation in Asia. China is where the company is aggressively planning to double its outlet to around 1500 by 2015. India, Asia's third largest economy also has Starbucks now. However, it would be interesting to see what strategy the company uses to please tea lovers with coffee.

Starbucks' financials are strong with 11% growth in revenue for first quarter over the last year. But a closer sector analysis shows that the company has yet not made profits in the UK in the past fifteen years except for a small profit in 2006.

Starbucks recently reported a loss of $30 million in the UK for the 12 months ended September 2012. The company is undertaking measures to make the segment profitable like closing unprofitable stores or relocating them to a more cost effective location. However, it would take some time for the investors to be sure if this decision of the company will pull it into a profitable zone.

Moreover, the company is highly overvalued with current PE of 35.3 and an estimated PEG of 2.2 for fiscal 2014.

The bottom line

McDonald's is a good investment opportunity for investors who want a regular payout from the company. As discussed dividend yield for the company is 3.1%, much higher as compared to its competitors Starbucks with 1.21% and Yum! 1.87%. Moreover, the company is in constant process of providing variations in its menu, location and operation making it an attractive opportunity for investors.

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Anjum Khan has no position in any stocks mentioned. The Motley Fool recommends McDonald's and Starbucks. The Motley Fool owns shares of McDonald's and Starbucks. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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