For the Long Term, McDonald's is as Golden as the Arches

By Jonathan Yates - July 27, 2012 | Tickers: KO, MCD, PEP, YUM | 0 Comments

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If ever there was a market climate for long term investors with a global outlook to prosper, this is it.  Due to disappointing results and what is turning out to be a gloomy earnings season, world class American stocks such as Coca-Cola (NYSE: KO), Yum Brands (NYSE: YUM) and PepsiCo (NYSE: PEP) are selling at reduced prices.  After a disappointing second quarter report, McDonald's (NYSE: MCD) is now joining the discount bin of blue chip stocks.

Profits were down for McDonald's for the second quarter by 4.5% to $1.35 billion, or $1.32 a share. This came in well below the analyst consensus of $1.38 a share.   While Wall Street was expecting $6.96 billion in revenues, only $6.92 billion was booked.  As a result, McDonald's fell about 2.5% in trading the day that Q2 2012 earnings were reported. 

This year has been a trying one for the shareholders of McDonald's.  Year to date, the Golden Arches have been seen a 7% drop in the stock price.  That is quite a change from the 19% average annual return posted over the last three years.  It is the same story with other global consumer giants. 

The Coca-Cola company is down 1.33% in trading for the last week.  Over the same period, PepsiCo is down 2.19%.  Yum! Brands, which owns and operates Pizza Huts and KFCs, has fallen more than 2.5% over the last week and over 4.6% over the last month of market action.

But there is no doubt that the Golden Arches will rise again.  There are about 33,500 restaurants in 199 countries that serve roughly 67 million people on a daily basis.   These restaurants are well run.  The profit margin for McDonald's is 20.36% and the return-on-equity is 38.20%, both very strong.  As a competitor comparison in the fast food sector, the profit margin for Yum! Brands is 11.58%.  For Wendy's (NASDAQ: WEN), another burger chain competitor of McDonald's, the profit margin is just 1.35% and the return-on-equity is only 1.46%.

With such a healthy profit margin, McDonald's can afford to pay a robust dividend of 3.18% with a dividend payout ratio of about 48%.  The average dividend yield for a stock on the Standard & Poor's 500 Index is around 2%, with a historic payout ratio of about 50%.   McDonald's is a "Dividend Aristocrat" like Coca-Cola and PepsiCo in that it has increased its dividend for at least the last 25 years.  Since 1990, the average dividend increase for McDonald's has been 19%.  That alone makes the stock attractive.

But what results in McDonald's being truly appealing as a long term buy is how well it is positioned to profit from global demographics.  The customer base and the one in the future is expanding for McDonald's as the world is growing richer, particularly in emerging market nations.  When consumers have more disposable income, they eat out more.  One of they first places they head to is the Golden Arches rising above the streets in 119 countries.

Both the global economy and growth for McDonald's are still expanding.  China just booked a 7.6% increase in its gross domestic product for the second quarter of 2012.  For the first three months of the year, India grew at a 5.6% rate.  Q2 2012 earnings for McDonald's featured same-store sales rising by 3.7%.

While growth figures are declining, the trend is positive in that China, India, and other countries are growing while McDonald's is still registering higher same store sales.  Trading around $12 a share in 2003, McDonald's rebounded with its "Plan to Win" grand strategy of five components: people, products, place, price and promotion.  From this came increased marketing, upgraded restaurants and a healthier menu to appeal to adults.   This successful strategy took the share price to over $100 earlier this year; and it will lead the recovery for the future.

More than just a "Dividend Aristocrat," McDonald's is global brand name royalty.  Like Coca-Cola and PepsiCo, McDonald's is one of the few brand names that simply cannot be replicated.  Consider all of the imports that have flooded the American marketplace in the post-World War II era: Not a single one has been a fast food restaurant to challenge McDonald's for consumer spending like Volkswagen did with automobiles, Sony did with personal electronics, and Samsung did with smart phones...or a soda maker to take on PepsiCo or Coca-Cola, for that matter. 

The more McDonald's falls, the higher the dividend yield and the more attractive the valuations.  For long term investors, that is a "Happy Meal" packed with both growth and income gains for the future.

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