McDonald's Is on the Value Menu

Bob 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) is an iconic American brand with a long and successful history of serving both customers and shareholders alike.  After a bumpy 2012, McDonald’s stock should be on the menu for any investor hungry for value and yield.

The company competes with smaller rivals Wendy’s (NASDAQ: WEN) and Burger King (NYSE: BKW), both of which have struggled recently.  The market capitalizations of these competitors are $1.8 billion and $5.7 billion, respectively.  Wendy’s reported a net loss for the fiscal third quarter despite a rise in same store sales of 4.1 percent year over year, as the company struggles to repay a heavy debt load.  Burger King had a poor third quarter as well.  Total same-store revenues dropped 25% during the three month period as opposed to the third quarter of 2011, and have dropped 11% during the first nine months year over year.

McDonald's operates in three major geographic segments:  U.S.; Europe; and Asia Pacific, Middle East, and Africa (APMEA).  McDonald’s generates roughly 68 percent of its revenues from outside the United States, with its largest contribution coming from its European segment.  The ongoing debt crisis and economic calamity in Europe have caused that segment to be a major drag on McDonald’s results.  Through Nov. 30, same-store sales in Europe are up only 2.7 percent year over year.  The company’s struggles in Europe were a major reason why. In October of this year, McDonald’s reported a decline in monthly same-store sales for the first time in nearly a decade.

McDonald’s has invested heavily to grow its operations in its Asia Pacific/Middle East/Africa segment (APMEA).  The company has targeted China as its main growth engine in the region, as an emerging middle class has propelled China to be the premier growth story of the developing economies.  McDonald’s is executing on its plan to open 225 to 250 new restaurants every year until it reaches its stated goal of 2,000 restaurants in China by the end of 2013. Same-store sales on a constant currency basis have increased in the company’s APMEA segment by 5.4 percent through Nov. 30.  At the same time, Wendy’s does not have international operations.  The company operates almost exclusively in the United States, with a few locations in Canada.  Therefore, Wendy’s will not be able to take part in the emerging market growth opportunity that McDonald’s will.  Burger King, meanwhile, does have international operations, but cannot claim to have nearly the emerging market footprint of McDonald’s.

The balance sheet for McDonald’s should be described as nothing short of fantastic.  Because roughly 80 percent of McDonald’s restaurants are franchise owned and operated, the parent company has been able to realize huge returns on equity and capital.  McDonald’s generated a return on equity of 40 percent during the trailing twelve month period, and in 2011 realized a return on invested capital of 37 percent.  Clearly, the franchise model has allowed McDonald’s to reap huge financial rewards by collecting licensing fees and royalties, while simultaneously placing the burden of maintenance on its franchise operators.

McDonald's has demonstrated a history of rewarding shareholders.  McDonald’s provided investors $6 billion in share buybacks and dividends in 2011 and management intends to continue those programs for the foreseeable future.  McDonald’s has increased its dividend every year for 36 years in a row, since its first dividend payment in 1976.  The company has grown its dividend by a compounded annual growth rate of 13 percent over the last five years.  McDonald’s has had a comfortable 69 percent free cash flow payout ratio through the first nine months of 2012, meaning the company has ample room to pay its current dividend and continue to increase the distribution in the future.  The stock now offers a yield of 3.5 percent, which is far better than the 2 percent yield on the S&P 500 and more than double the current yield on the 10-Year Treasury bond.  McDonald’s has rarely yielded 3.5 percent, as the company’s extremely valuable brand and predictable cash flows have traditionally awarded the stock a premium valuation.

Peers Wendy’s and Burger King also pay dividends to shareholders, but have much less impressive track records.  The companies are currently yielding 3.3% and 1%, respectively.  Wendy’s cut its dividend during the fall of 2008 and Burger King has only paid one dividend since its decision to go public again in 2012.

McDonald's had a rough 2012.  The stock began the year trading for $100 per share and has since fallen to its current level of $89, losing about 11 percent of its value.  Meanwhile, McDonald’s earned $5.27 in 2011 and analyst expectations call for earnings of $5.31 for fiscal 2012.  At a price of $89 per share, the company trades for just under 17 times its trailing twelve month earnings and has a forward P/E ratio of just 15.4 for fiscal 2013.  Consequently, the company provides an above-average dividend yield, a rock solid balance sheet, and a modest valuation.  McDonald’s stock is trading at an attractive entry point at its current price.

Robert Ciura owns shares of McDonald's. The Motley Fool owns shares of McDonald's. Motley Fool newsletter services recommend Burger King Worldwide 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!

blog comments powered by Disqus