McDonald's: It All Comes Down to Leadership Innovation

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

For McDonald's (NYSE: MCD), the key to its past success has been a commitment to its core business while continually innovating its product line to meet the needs and wants of the ever-changing consumer. The world of fast-food has evolved in many ways over the past three years alone and this has directly impacted McDonald's business. The entry and growth of players like 5-Guys and Chipotle (NYSE: CMG) along with the rising competition from Wendy's (NASDAQ: WEN), Burger King (NYSE: BKW), and YUM! Brands (NYSE: YUM) has changed the market and made it more and more essential for McDonald's to innovate its product line, while staying true to its core. McDonald's completion of FY12 and Q4 marks an end to a difficult year for the fast-food giant. Though making strides in terms of menu offerings and value-meals, the company saw soft sales characterize the past several periods with expected negative sales growth in January.

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(McDonald's Earnings Release)

Though not alarming due to the competitive landscape and slowdown in the global economy, these earnings do show the need for McDonald's to have a constant eye on the competitive landscape and what they can do to differentiate against the growing number of competitors. What matters for investors is how the company is preparing for FY13 and what these plans will mean for stock performance and future growth. The answer to this question lies in the hands of Don Thompson:

Throughout 2012 we concentrated our efforts behind the global priorities that represent our greatest opportunities under the Plan to Win - optimizing our menu, modernizing the customer experience and broadening accessibility to our Brand. McDonald's continued to grow by remaining focused on what matters most to our customers, although our results reflect the impact of the challenging global operating, economic and competitive environment. Our overall performance is a testament to the underlying strength of our business and our dedicated System of franchisees, suppliers and employees who continue to drive toward our mission to become our customers' favorite place and way to eat and drink.

These words by Thompson show a clear understanding of what will be necessary to succeed in the coming years. Though many CEO's speak these same types of words, Thompson has shown that McDonald's is willing and able to adapt in this changing world. This quarters earnings were in large part driven by a focus on "value meals" and specifically an update to the dollar menu. This approach is what is necessary for long-term success, but does squeeze margins by driving up volume and diminishing profit. Though in the short-term this innovation and resurgence of the dollar menu may not add substantive incremental earnings, in the long-term it is the only way for McDonald's to stay ahead of its international counterparts YUM, Wendy's, Burger King, etc.

As aforementioned, competition within the fast food sector is rising and pricing is becoming more and more important. Wendy's introduced its "Right Size Fits All" menu that focuses on value and directly competes with McDonald's. Additionally, in the company's fourth-quarter results, CEO Emil Brolick stated that the company was focusing on comtemporarizing the customer experience. The issue for investors with Wendy's is the company's low margins in comparison with its peer group. YUM! Brands has seen rising competition internationally and a slowdown in Chinese growth that makes the company a higher risk proposition for investors. Though Wendy's and YUM! each provide investors with strong financials and established brands, McDonald's is positioned well in the market to drive incremental sales and follow through with heightened earnings due to the company's strong history of changing with the times and consistently strong margins.

For investors, McDonald's is currently priced well and is in a strong fundamental position to perform over the long-term time horizon. In terms of valuation, McDonald's is valued at:

Forward Price/Earnings: 14.71

  • YUM: 17.95
  • Wendy's: 25.9
  • Burger King: 25.13

PEG Ratio: 1.86

  • YUM: 1.56
  • Wendy's: 2.59
  • Burger King: 1.74

EV/EBIDA: 9.34

  • YUM: 11.02
  • Wendy's: 9.06
  • Burger King: 14.12

These figures illustrate that although McDonald's is not cheap, the company is valued fairly. In addition to being fairly valued, though, McDonald's also rewards its investors with a strong dividend, which makes the company even more appealing. The fundamental strength to McDonald's as a dividend play is that the company's debt/equity ratio is roughly 1. This shows a company that uses debt, but is not over leveraged.

Dividend: 3.30%

  • YUM: 2.10%
  • Wendy's: 3.10%
  • Burger King: .9%

Profit Margin: 19.82%

  • YUM: 11.89%
  • Wendy's: .12%
  • Burger King: 4.39%

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(Yahoo! Finance) 

The key for investors with McDonald's is that the company is a good mix of a long-term stability play, a dividend winner, and a growing company both domestically and internationally. With a less aggressive international growth strategy than YUM and higher margins than Burger King and Wedny's, McDonald's provides stability and a strong business model to investors. The future of the company is in the hands of Thompson and his team. The key is for them to innovate with new product lines that speak to both the current McDonald's customer along with the prospective McDonald's customer. Investors should keep a close eye on the new offerings the company is revealing as they are the key to McDonald's success going forward into an age of heightened competition and a greater emphasis on value.

(All financial metrics referenced above are obtained from Yahoo Finance, CNBC Analytics, S&P Capital IQ and Thomson Reuters.)

JustinWeinstein has no position in any stocks mentioned. The Motley Fool recommends Burger King Worldwide, Chipotle Mexican Grill, and McDonald's. The Motley Fool owns shares of Chipotle Mexican Grill and McDonald's. 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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