Is McDonald’s Attractive Right Now?
Meena is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
McDonald’s Corporation (NYSE: MCD) is an attractive investment owing to its impressive profitability, strong cash flows, and notable dividend yield. The world’s largest food chain offers an extensive and diverse menu to its millions of customers, and its sales have been constantly increasing, with FY11 revenues amounting to 27bn with an ROE of 38.2%. The global contribution in total revenues is notable: European subsidiaries and owned restaurants contributed 40% of overall sales despite the debt crisis overcasting most European economies. Sales from emerging markets in Asia/Pacific, the Middle East and Africa doubled in six years. Consequently, EPS increased from $4.58 in FY10 to $5.27 ($5.35 for most recent quarter) in FY11. McDonald’s pays an annual dividend of $2.6 per share.
The US restaurant industry has been stronger recently due to an increase in consumer spending. This sector has shown low responsiveness to the recent economic slowdown in the US and around the globe, and, with a mild recovery in place, we expect all the major players to increase their bottom lines this year. The only caveat to growth could be tightened credit conditions, mainly for medium to small players; however, this won’t be an issue for firms like MCD with over 7bn of operating cash flow. International expansion is one area of concentration for the food industry with ample growth prospects, particularly in emerging markets. MCD has a significant presence in these markets, notably in China and India. On the cost side, MCD expects the cost of its basket of goods to increase by 2.5% to 3.5%. This minimal increase is unlikely to apply any material pressure on the margins, and therefore we expect profitability to increase, providing support to the free cash flows.
MCD does face some competition from its peers, mainly comprised of YUM Brands (NYSE: YUM), Chipotle Mexican Grills (NYSE: CMG) and Buffalo Wild Wings (NASDAQ: BWLD), which have recently performed well. Some analysts are getting concerned, however we do not feel that this will cause major damage. First, if size does matter, then MCD has a much larger network than its peers. Second, MCD enjoys both economies of scale and scope to a much greater extent than its rivals, with a net margin of 20.26% compared to 11.81% for YUM, 9.63% for CMG and 6.31% for BWLD. Third, MCD, on account of its superior margins, is expected to absorb food inflation and other technological changes much better than its peers, who are constrained both by size and profitability. Lastly, MCD can capitalize on its ability to attract the budget conscious customer with discount offerings and menu diversity that definitely give it a competitive advantage.
The share price performance of MCD has been impressive, with a three year compound return of 21.1% compared to 14.9% for DJIA and 14.1% for S&P 500. The firm has a trailing P/E ratio of 16.7, offering a dividend yield of 3.1%. Given the strong market position of MCD and that there are no material threats to its cash flow, we expect the P/E ratio to stabilize around 14.6, with a forward price of $101.1 offering a 12.5% upside to its current market value. McDonald’s is also cheap relative to its peers. YUM has a trailing PE ratio of 20, versus 28 for BWLD and 52 for CMG. McDonald’s is also more popular among hedge funds than its peers. Billionaire Jim Simons invested nearly $500 million in MCD (see his top holdings). We think McDonald’s is a great long term stock pick, but given the economic weakness in Europe we would wait for a better entry point in the short term.
This article is written by Nawazish Mirza and edited by Meena Krishnamsetty. They don't own shares in any of the stocks discussed in this article. The Motley Fool owns shares of Buffalo Wild Wings, Chipotle Mexican Grill, and McDonald's. Motley Fool newsletter services recommend Buffalo Wild Wings, Chipotle Mexican Grill, McDonald's, 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.