This Is One Cheap Burger!

Shmulik 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) has been having a tough year. Due to global woes regarding weak sales in the face of a potential slow down, particularly in Europe, investors figured that the mighty growth potential of this giant has come to a halt. The graph below tells us the whole story.

After reaching the $102 price level in January, investors quickly fell out of love with the giant burger chain. Shares of the company have lost 20% since then, and are now sitting at their 52 week lows.

Value or value trap?

Our first goal is to determine whether McDonald's has turned into an unloved value company or a dangerous value trap. In order to do just that, we will first attempt to figure out why this company suddenly became so unloved. There are 2 main reasons for this:

  1. It all started with the company's Q3 earnings miss. McDonald's reported an EPS of $1.43 versus an estimated EPS of $1.47. This 4 cent difference was enough to cause a drop of 6% in the share price.
  2. The company's global comparable sales decreased by 1.8% in the month of October. Is it that horrible a drop? Probably not. But since it is the first drop in sales in over 9 years, some investors perceive this as a red flag.

In order to determine whether McDonald’s offers real value, we will compare the company's numbers with that of a few leading peers in the fast food restaurant business, such as The Wendy's Company (NASDAQ: WEN), Yum! Brands (NYSE: YUM) and Burger King Worldwide (NYSE: BKW).

  Forward P/E Quarterly Revenue growth Operating Margin Div. Yield
McDonalds  14.5  -0.2%  30.3%  3.6%
Burger King   21.3  -25.8%  21.8%  N/A
Yum! Brands   18.7  9%  16.25%  1.9%
Wendy's   21.9  3.8%  7.32%  1.9%

As we can see from the table above, McDonalds stands as a clear winner. The stock is the cheapest in terms of P/E and it is also the most rewarding in terms of operating margin. Add in the dividend yield and you get yourself a real bargain.

The catalyst

The numbers above are great. But very often, you need a catalyst for the share price to increase and reflect true value. In McDonald's case, the catalyst is no other than undervalued real estate. The company normally owns the land of all of its restaurants, which it then - rents out to its franchisees. In today's depressed real estate prices, all of its properties are kept at low cost on the company's balance sheet. You see, McDonald's is basically a real estate empire only waiting to be exposed.

How to take advantage of this opportunity

McDonald's is a great company with a fantastic distribution channel, great product, and lots of property that it owns. And finally, the stock is selling on the cheap. I believe now is the right time to be long McDonald's. You can do that in one of 2 ways:

  1. Buy shares of the company.
  2. Sell the January 2013 Put options, at the $85 strike, on the stock. These put options will obligate us to buy shares of the company IF they trade for less than $85 come January 2013. As a reward for our trouble, we will receive an immediate payment of $2.90 for each Put option we sell. This is a nice premium to receive simply for the obligation to buy shares at a predetermined price at our convenience. In my opinion, this is a classic situation of "heads I win, tail you lose".

The Foolish conclusion

I believe McDonald's is an unloved company right now, but its core business is well intact to keep delivering growth and dividends back to shareholders. This is the time to initiate a stake in this great company either through an outright purchase of shares or through the options strategy I described above. I urge you not to miss this opportunity.


shmulikarpf owns shares of McDonald's. The Motley Fool owns shares of McDonald's. Motley Fool newsletter services recommend Burger King Worldwide, 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.

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