Should this Stock be on Your 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 performance, McDonald’s has returned to solid footing and its stock should be on the menu for any investor hungry for value and yield.

More than just hamburgers

Over the years McDonald’s has expanded from its humble beginnings.  The company has launched a number of successful product initiatives.  Recently the company points investors to the popularity of its McCafe brand of coffees and breakfast items.  McDonald’s has opened 1,500 McCafe locations in its European segment alone.  The chain’s revenue increasingly depends on its much higher-margin coffee, and it plans to continue expanding the McCafe brand to take advantage of consumers who want coffee at reasonable prices.

Drinks like coffee and fruit beverages have been a boon for McDonald’s, as these products generally provide higher margins than food.  Coffee and fruit-based drinks now account for 10% of the company's revenue, with coffee making up around 4% of revenue, double its percentage from five years ago. In fact, drinks sold though the McCafe brand alone add over $125,000 in annual sales per restaurant.   

Starbucks (NASDAQ: SBUX) needs to take McDonald’s foray into coffee and specialty drinks seriously.  The fast-food chain modeled its drink lineup from Starbucks, which should start to see McDonald’s as a major rival.  In fact, many of McDonald’s coffee offerings look and taste a lot like menu items found at Starbucks.

Starbucks is a successful business with a valuable brand, but there’s little doubt that McDonald’s is encroaching on its turf and is there to stay.  U.S. consumers are tightening their belts, especially in the current environment of painfully slow recovery in employment and wage growth.  It’s certainly plausible that McDonald’s will make further market share gains by selling $1 coffee, as opposed to the much more richly priced products at Starbucks.

To be fair, Starbucks reported record first-quarter results, with global comparable store sales growth of 6% year over year.  Earnings per share grew 14% to a record $0.57 from $0.50 the same period a year ago.  Furthermore, the company has aggressive growth expectations for 2013.  Starbucks plans to open 1,300 new stores globally this year, representing 22% growth versus 2012.

Starbucks is very profitable, but trades for 30 times its trailing twelve-month earnings per share.  Clearly, the market has set high expectations for Starbucks going forward.  The company could absolutely meet or exceed these expectations, but investors would be wise to not entirely dismiss the competitive threat posed by McDonald's (and other restaurants) that sell coffee at much cheaper prices.

A Less Complicated Play on China

For investors interested in international exposure, you might think that Yum! Brands (NYSE: YUM) is better than McDonald’s as a way to play emerging market growth in developing economies like China.  It’s true that Yum! derives over half of its total sales from China alone.  Moreover, the company reported full-year earnings growth of 13% to $3.25 per share, excluding special items, and the company’s growth plans remain solidly intact, as the company opened a record 1,976 new international restaurants.

However, Yum!’s having some problems in China, to put it mildly.  In December the company revealed that its KFC sales in China would suffer after the government announced it was investigating a chemical residue found in a small portion of its chicken supply.

Yum! CEO David Novak said on a conference call with analysts that the company will need time to restore its reputation with Chinese consumers. Yum! is refining and strengthening its food safety standards and plans to begin an aggressive marketing campaign to restore KFC's brand image.

If you’d rather altogether avoid the headache presented by Yum!’s issues in China, you might be better served looking towards McDonald’s.  McDonald’s has put huge efforts into developing its operations in China. 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. 

Not only has McDonald’s charted a path to be dominant in China, but the company has now targeted growth through a different member nation of the BRIC countries:  Russia. McDonald's was the first international fast-food chain to tap the Russian market, and is now digging deeper into its foothold in the country. McDonald's has 357 restaurants in more than 85 Russian cities, of which 46 were opened last year.  In addition, the company plans to open at least 150 self-operated restaurants in Russia over the next three years. 

A dominant business with a modest valuation

In January, McDonald’s reported great full-year 2012 results.  Global comparable sales increased 3.1%, and consolidated revenues climbed 5% on a constant currency basis.  Diluted earnings per share increased 5% as well on a constant currency basis to $5.36 per share.

At $95 per share, the stock trades for slightly more than 17 times its 2012 diluted earnings per share.  Even better, McDonald’s is one of the most shareholder-friendly companies in existence.   Last year, McDonald’s returned $5.5 billion to shareholders in the form of dividends and share buybacks.  The company increased its dividend 10%, and will surely do so again in the fall.

McDonald’s isn’t a screaming value, but premium businesses command premium valuations.  The company is one of the most successful and best-managed in the world.  As Warren Buffett famously said, it’s far better to own a wonderful company at a fair price than a fair company at a wonderful price.  I think that’s what we’ve got with McDonald’s.  The company offers a 3.25% yield that trounces the yield on the broader market, and has a well-defined growth path ahead of it in international markets.  McDonald's should be on your watch list going forward.

rciura owns shares of McDonald's. The Motley Fool recommends McDonald's and Starbucks. The Motley Fool owns shares of McDonald's and Starbucks. 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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