Not All Great Brands Are Equal: 1 To Buy, 2 To Avoid
David is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Investing in top brands is often the safest and most reliable way to "win" in an uncertain economy. However, at times the safety makes stocks so overvalued that an investment becomes undesirable. In my view, Coca-Cola (NYSE: KO) and McDonald's (NYSE: MCD) have become too expensive compared to other strong brands, like Intel (NASDAQ: INTC). While I generally favor broad diversification, Coca Cola and McDonald's are much pricier than Intel, which is an equally strong brand but positioned for greater upside.
Coca-Cola & McDonald's
These are two of the most well-known brands in the world. Moreover, they are also getting more serious about geographical diversification. Coca Cola acquired an approximately 50% stake in Saudi Arabia-based Aujan Industries to help confront PepsiCo's leading position in the Middle East. Coke’s competitor controls 60% of the market in Saudi Arabia, so this was a bold move that, I believe, sets the tone for greater takeover activity.
Between the takeover in Saudi Arabia and the bottle divestments (particularly in Germany), it is clear that Coca Cola is trying to position itself as a possible acquisition vehicle. Some argue that this "global growth" strategy will be compromised by the fact that Coca Cola has been accused of tampering with beverages in northern China. This is not, in my view, a major headwind to value creation, since the demand for beverages and trust in product safety continues to offset negative press.
Similarly, McDonald’s has strong fundamentals and offers great safety. A second quarter miss should not detract from the overall consistency in earnings growth. Moreover, this miss is more due to a soft macro environment that poor managerial decisions. To confront this headwind, management is also planning on increasing advertising and launching new products - strategies that are similar to those implemented by peers.
I do not believe that McDonald's strategies will meaningfully pay off - consumers can be very unpredictable. Even if they do "succeed," success will come at the cost of lower margins. Input inflation is already placing a toll on the company’s underlying fundamentals, with weaker than expected margins (down 80 bps year over year) posted in the second quarter. Competition has also risen—something that management noted. Below-average unit growth may be offset by improving ROIC and share gains, but this has already been factored into the stock price.
All in all, McDonald's and Coca Cola are both too expensive to justify an investment. As costs and competition rise, even the best of brands will struggle to make the case that upside outweighs downside. Shareholders of both companies have betted up the business to a point where the downside overwhelms the degree of safety. Accordingly, I recommend holding out and investing in other strong brands, like Intel.
As one of the most (if not the most) well-known semiconductor producer, Intel is well positioned to ride the positive secular trends of technology. The Street is currently bullish on technology, yet fails to meaningfully appreciate an essential part of the tech sector: semiconductors.
During the second quarter, management reported strong results that once again confirmed how undervalued the business is. Market share grew considerably, which points favorably to Intel outpacing the competition in MPUs. Revenue grew 5% quarter over quarter—a pace that warranted the company increasing third quarter revenue guidance up 6% quarter over quarter. With utilization already adjusted and little risk to margins going forward, Intel is well positioned to grow earnings more than originally anticipated.
Equipped with a solid balance sheet that has $13.6 billion in cash and short-term investments, the company can continue to increase its shareholder-friendly capital allocation policy. $1.1 billion worth of dividends and $1.1 billion more in share repurchases have demonstrated management’s commitment to returning free cash flow to shareholders. It is this kind of safety, combined with strong operations, that warrants making an investment in a strong brand like Intel.
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TakeoverAnalyst has no positions in the stocks mentioned above. The Motley Fool owns shares of Intel, The Coca-Cola Company, and McDonald's. Motley Fool newsletter services recommend Intel, McDonald's, and The Coca-Cola Company. 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.