McDonald's: Why Investors are Lovin' It
Bobby is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
McDonald’s (NYSE: MCD) has reported impressive results for the first quarter of 2012 though roughly in line with the consensus estimates. Net income at $1.27 billion ($1.23 a share) was up 7% over $1.21 billion ($1.15 a share) in the previous year. Restaurant sales for restaurants which were open for a minimum of 13 months increased by 7.3% which was an improvement over the 6.7% consensus. Sales at US restaurants rose 8.9% while sales in Europe led by the UK and Russia showed growth of 5% despite the concerns that the economic woes in Europe would depress demand. Sales in Africa and the Middle East were up by over 5%. The continuing success was attributed the introduction of new items such as coffee frappes and fruit smoothies which enjoy high profit margins and increasing popularity. The relatively low prices and the encouragement of custom during the working day also played their part. The recent addition of oatmeal and Chicken McBites to the menu is also working out well.
The company is the epitome of a fast food chain and it innovates constantly by introducing fresh and attractive new items on the menu in response to the constantly changing public taste. From its historic past of serving just burgers and fries, the company now offers the abillity to choose between many other items such as salads and fruit smoothies if you are health conscious. At the end of 2011, McDonald's had 6,435 company-owned restaurants and 27,075 franchises. This seemingly large number of outlets is actually quite small on a global basis and it would be a long time before saturation becomes a concern. The bulk of the newest stores that the company plans to open are located in the United States but the majority of the new restaurants would be in the Asia-Pacific region. At this pace, market share in the Asia-Pacific is expected to equal that of the United States in about five years time.
One major competitive advantage that McDonald's has created is the success of its franchising business model with over 80% of its total outlets being franchised. None of the competitors are anywhere near as successful. One of the major advantages of this approach is that free cash flow need not be spent on new outlets but can be used to boost business growth. Burger King has begun the process of franchising a large part of its outlets both in the United States and globally as it expects to complete the process by the end of 2013. Yum! Brands (NYSE: YUM) is also gearing up its act and only about 13% of its US restaurants are now company-owned. Because franchisees invest their own capital, they are highly motivated to seek profitability which results in larger royalty payments to the franchise parent.
Everybody in the fast food business is expanding globally at a rapid pace because developing markets offer the maximum potential for long-term growth and profitability. China, for instance, offers phenomenal growth and here Yum! has performed extremely well on the back of its KFC franchise. In Europe, the McCafe locations which number about 1,500 are directly focusing on the coffee and beverages market in competition with Starbucks (NASDAQ: SBUX) and Dunkin' Donuts (DNKN). This is a promising market when you consider that more than two billion cups of coffee are consumed everyday throughout the world. McDonald's is experimenting with dessert kiosks in the Asia-Pacific and will roll them out worldwide if the results are good. Just as drive through services galvanized the fast food industry years ago, the company is hoping that food delivery services that it is introducing would have the same effect because of the convenience to the customer. Wendy’s (NASDAQ: WEN) is trying to catch up by matching the offerings on McDonald's menus and teaming up with Starbucks which now sees McDonald's as direct competition.
Probably the biggest challenge that McDonald's is facing is the departure of longtime CEO Jim Skinner who is retiring. Skinner has transformed the company into a world leader and his successor Don Thompson who has been Chief Operating Officer is stepping into a very large pair of shoes indeed. Considering that Thompson has no overseas experience coupled with the importance of the company's overseas business, it would be interesting to see how he moves forward.
Let us now consider McDonald's as an investment prospect. I should point out that on the basis of earnings multiples; it is arguably the cheapest stock among its peers. And with different degrees of economic uncertainty throughout the world, it is comforting to hold stock in a company that operates in so many different markets with the diversification acting as a cushion for risk. Investments like this are less risky than investments in companies that operate in more narrow and sharply defined markets. Even if it takes time for stock prices to pick up, you have the consolation of an extremely attractive dividend yield of nearly 3%. When you consider that the dividend has been raised for 35 years in a row and the solid performance of the company, I can safely assure you that your dividend is not at risk. In fact earnings are expected to grow to $5.71 a share in 2012 and $6.20 in 2013 so there is reason to believe that you can expect an increase in dividends.
People will continue to eat meals and drink beverages if they are reasonably priced and this is the strength of the company. In fact its forays into the high-end beverage market such as coffee would have the effect of improving operating margins. If you are looking for a long-term stable investment with attractive dividend yields, there are very few stocks that rival McDonald's as potential investments for you. If you have an existing investment, you should definitely hold and add to your holdings at the price declines.
BobbyFisher has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. 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.
