Do These Companies Really Provide a Value Opportunity?
William is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Sometimes companies will report an increase in revenue, profit and cash flow and the stock price will still fall simply because they didn’t meet the expectations of Wall Street. It seems like the higher the valuation the more sharply they fall. The fall in companies’ stock prices is what gets the blood flowing in value investors such as myself. In the past three months (see graph below) Chipotle Mexican Grill (NYSE: CMG), Yum! Brands (NYSE: YUM), and McDonald’s (NYSE: MCD) have fallen 29%, 10%, and 2% respectively. Investors have to do their research to find out if these companies truly present a value. They have to ask themselves, “Do These Companies Really Provide a Value Opportunity?” Investors wouldn’t be very Foolish if they didn’t ask.
Cheap but Not Cheap Enough
Chipotle Mexican Grill is an excellent company that sells high quality food at reasonable prices. Its revenue has grown 22% per annum between 2009-2011. Its free cash flow has also grown 35% per annum during the same time. Its return on equity was 21% in 2011.
However, when Chipotle Mexican Grill came out with the earnings release on July 19, its year to date cash flow had declined 2% and Mr. Market drove the price south roughly 31%. The company continues to grow its top line and net income, so I think the cash flow will improve over the long term. It is now trading around $295 per share versus the $403 per share before the earnings announcement. An investor who bought the stock at roughly $400 per share or above was taking on extra risk in the form of market price risk. Even after the correction the P/E ratio still stands at 36. This company’s stock is cheaper, but not cheap enough for me. If this company disappoints the street again, then the stock price will go off another huge cliff.
Wage Inflation Hits China
Yum! Brands is expanding briskly into emerging markets. Its year to date net income has increased 36% versus the same time last year. Its free cash flow has declined 13%. Over 68% of their operating profits came from outside the United States for the 6 months ending June 16. Its fastest growing segment is the China segment which saw revenue growth of 33%. However, Yum! Brands has been struggling with wage and commodity inflation in China. Its wage inflation stands at 15% so far in 2012. The company’s brisk expansion in China should offset some of this increase in cost. Also as the middle class grows in China they should be able to raise prices to compensate. The P/E ratio of Yum! Brands is still a little too high for my preference; however, now is a better entry point then three months ago. This company also suffers from adverse currency translations.
The Scourge of the Strengthening Dollar
McDonald’s stock price fell the least amount of the companies discussed here today over the past three months. Their net income and free cash flow declined 0.2% and 13% respectively for 6 months ending June 30. This has been impacted by the strengthening of the dollar against many currencies particularly the Euro. Year to date the dollar strengthened 3% according to Yahoo! Finance. The dollar strengthened 7% in May alone. This highlights an aspect of political risk driven by foreign macro economic factors such as the Euro crisis. The year to date European segment sales would have been 8% higher if it wasn’t for the currency translation. Without the adverse impact of the strengthening dollar McDonald’s year to date operating income would have increased 6%, which is higher than the 3% reported. This tells me that the demand for their product is still great and will probably continue despite the friction caused by the strengthening dollar.
McDonald’s is the cheapest company discussed here based on a P/E ratio at 17. This company also carries a slightly high price tag, but combined with the dividend yield of 3% along with strong organic growth in its fundamentals the price appreciation potential is far better than the other two companies I highlighted.
McDonald’s with its relatively low valuation and growth in fundamentals, when you factor out the impact of the stronger dollar, gives investors the most price appreciation potential. Chipotle Mexican Grill’s stock price will drop off another cliff if they disappoint Wall Street again. Yum! Brands is not quite as cheap as McDonald’s but robust growth in China could give Yum! Brands stock superior upside potential. Don’t take my word for it, be Foolish and do your research before buying.
stockdissector has positions in McDonald's mentioned above. The Motley Fool owns shares of Chipotle Mexican Grill and McDonald's. Motley Fool newsletter services recommend Chipotle Mexican Grill, 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.