McDonald’s Corp. (NYSE: MCD) is thriving despite a difficult environment.
This very difficult environment is sending a lot of consumers scrambling for cheaper alternatives in dining. That is where McDonald’s distinguishes itself. With January same-store-sales up more than 7% worldwide – even in the face of the global financial meltdown – McDonald’s is proving that it can not only execute, but thrive. Indeed, sales in Asia were up 10%, while those in Europe were up 7%. Even U.S. sales were up 5%.
McDonald’s is the unparalleled leader in the arena of quick service and value dining. With roughly 31,000 restaurants in 118 countries, a balance sheet laden with $1.5 billion in cash and a size and market capitalization that dwarfs the competition, it is almost impossible to compete against the Golden Arches.
It doesn’t stop there, either: In an environment such as this one, the strong get stronger and run away with the market as the weak disappear.
The Oak Brook, Ill.-based McDonald’s is the world’s leading food-service retailer, with more than 30,000 local restaurants serving 52 million people in more than 100 countries every day. More than 70% of McDonald’s restaurants are owned by independent local men and women. McDonald’s is also one of the world’s most-recognizable and most-valuable brands.
Not only is McDonald’s the largest, but its huge geographic diversification and economies of scale imbues the company with its many enduring competitive advantages. These advantages result in huge cost savings that are not as important in good times, when the industry has runaway pricing power. During lean, economic times, however, those cost savings are the difference between life and death. If you are a supplier, and you sell to the Golden Arches – much like selling merchandise to Wal-Mart Stores Inc. (NYSE: WMT) – you have very little bargaining power.
To the advantages related to economies of scale and migration to cheaper alternatives by consumers, you need to add the renewed inflation policy and the drop in commodity prices. Other than the cost of chicken, which is about 10% higher than last year, all other key food ingredients have dropped between 5% (beef) to 45% (milk). This will show up nicely in McDonald’s margins, which, coupled with sales growth, will give the company’s bottom line a nice push higher.
Who says that you cannot expand profits in a recession?
Indeed, McDonald’s is maintaining operating margins in excess of 25% and a net margin of 18%. This provides the firm a rock-solid cash flow, which, together with a very low level of debt, puts the company in the ideal situation to face these times. McDonald’s nice 3.5% annual dividend yield is very safe, meaning the company will continue its 30-year history of paying cash dividends. It will be easy to do this, since the dividend payout comprises less than 50% of the company’s yearly profits.
Also safe are the $5.5 billion in share repurchases planned by the company for 2009. These planned stock repurchases are up from last year’s $3.8 billion and represent a sure threat to any potential shorts. These strong profits produce a stunning 30% return on equity, given McDonald’s franchised model: Because nearly 80% of its restaurants are franchisee-owned restaurants, the company’s capital requirements are very low.
We mentioned shorts: The few that we’ve seen are already running to cover. In fact, of the entire restaurant sector, McDonald’s is the company with the least amount of shorts. That tells you right there that the pros do not want to risk it against Big Mac. If anything, you are almost assured that in this environment, McDonald’s will outperform most of – if not all – of its competition.
McDonald’s shares, trading at only about 15 times last year’s earnings and 13 times next years’ earnings – are right now at valuations that are well below historic parameters. In fact, the stock has come down nicely (for us buyers) recently as the market has sold off, allowing us to buy in at an attractive valuation, close to the bottom of last year’s range.
But this is not all. The U.S. dollar rally typically hits firms like McDonald’s, which enjoy a huge international diversification. But the rally is running out of steam, as global economic activity stabilizes and starts bouncing back later in the year, driven by globally-lax monetary and fiscal policies and the mammoth fiscal incentive packages, especially in China and the United States. As the dollar starts losing ground on other currencies, then McDonald’s international profits should rise.
New products will also contribute to higher margins. The company is introducing some products that will help bring traffic away from less-casual venues over to the Golden Arches. With these new products, McDonald’s will attack its more-pricey competitors by offering some comparable products at better prices. I would not like to have one of the competitors’ franchises if I have a McDonald’s nearby these days.
So with expanding sales and profits on the back of insurmountable competitive advantages, a solid balance sheet and a sound management that is executing thoroughly, we take advantage of this great opportunity to jump into McDonald’s.
Recommendation: Buy McDonald’s Corp. (NYSE: MCD), a leader in its sector, which has global competitive advantages, and which is trading well below historical valuations, making it a sound bargain (**).
[Editor's Note: Veteran Wall Streeter Horacio Marquez is the author of Money Morning's hugely popular "Buy, Sell or Hold" (BSH) series, and is also the editor of the longstanding "Money Moves Alert" trading service.
As the hundreds of thousands of readers across the Internet who've read Marquez's insightful BSH missives know, the longtime Wall Street insider has a knack for picking stocks that are poised to move. Indeed, when he recommended the Brazilian exchange traded fund - the iShares Brazil Index (NYSE: EWZ) - in late October, it zoomed 42% in six days.
In a new free report, Marquez has identified a category of stocks he has labeled "rocket stocks," which display key characteristics hinting that they're ready to move. One such characteristic: Heavy insider buying. In fact, one particular sector right now is seeing especially heavy insider buying - and many investors will be surprised to discover just what sector it is, and what companies top executives are buying into. For a free report that details these "rocket stock" plays, and that outlines this torrent of insider buying, please click here. The report is free of charge.]
(**) Special Note of Disclosure: Horacio Marquez holds no interest in McDonald’s Corp. (NYSE: MCD).
Friends,
The recommendations of the author stand completely on the Finance point of view, where he talks about the intrinsic values and P/E ratios. Yes, from what I have understood, I appreciate the valuable insights given by the author.
When it comes to the morality point of view, I assume the opinions vary on an individual basis. Perhaps, we must understand that there is a 'trade-off' for everything, and the trade-off is a serious one. For instance, the cheap and quick food at MCD, is a consolation for people especially from the low-paying jobs. Sometimes, a diet in itself forms an important criteria, leaving the dietary values aside. Ofcourse, MCD is a cost-leader in that segment of the market.
I agree with Jay Salvati. Investing is more than just making money.
McDonald's is a company I will not purchase products from or invest in.
Horacio,
I completely agree with you about MacDonald's however, I am rather upset at the fact that a company that makes our nations health worse day by day has been placed into such positive momentum for it's stock to rise.
As investors, do we pledge ourselves to moral integrity (investing in companies that help people, make them healthier and so on) or absolute profit?
Truly a catch 22.
– Jay Salvati
GROW UP!! No one is FORCING anyone to buy from McDonald's. Are you an alchoholic because you have a glass of wine with dinner? Purchasing a hamburger is not consuming 3 meals a day of their products! I'm off to enjoy a BigMac for Saturday lunch—-hope your cottage cheese and carrots fill you up as you remain righteous! (First time I have EVER sent an e-mail response)
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I say, good for McDonald's. They did their homework. They deserve to be the market leader. Besides, the menu is not all that bad. However, their SWOT shows that their primary weakness is the lack of courteous treatment to guests. This is definitely an issue they need to work on. I do not feel good about spending my money and being treated rudely while doing it.
Thanks and God bless.