Introduction
McDonald's (MCD) declined by 14.32% off its 52 week high. This has been a difficult second half for investors. I believe the growth factors have been largely miss-priced, which will give investors an opportunity to buy the company at a bargain going into 2013.
Qualitative Analysis
Source: Information pertaining to McDonald's came from the shareholder annual report
The macroeconomic environment remains strong for McDonald's. The proven business model, international growth, and improving profit margins will cause the stock to perform in line with growth expectations going forward.
McDonald's continues to grow rapidly in its growth markets such as Europe and Asia. The Asian division grew revenues by 18% between 2011 and 2010. European sales grew by 13% over the same period; it is likely that sales growth will continue in the double digits as investors have over sold the stock.
McDonald's was able to increase operating margins by 0.6% between 2010 and 2011. While operating margins remain at a respectable 31.6%. McDonald's management plans to improve growth by focusing on increasing the number of 24 hour restaurants. McDonald's will remodel pre-existing stores to improve the overall quality of the brand. By improving the quality of restaurants, McDonald's will be able to charge higher prices going forward.
The stock is likely to grow, making this a great investment opportunity. Eurasian growth, higher-end branding, along with improving profit margins keeps me optimistic on the company going forward.
The stock competes for market share with Yum Brands (YUM), Chipotle Mexican Grill (CMG), Tim Hortons (THI), Burger King (BKW), among many others.
Technical Analysis
The stock continues a down-trend going into 2013. But I anticipate the stock to eventually find support at approximately $84.00 per share. The stock will make a significant move by July 2013 in an upwards direction. My forecast assumes that the stock is likely to break above the descending triangle by mid-June, making McDonald's a compelling long idea going into the second half of 2013.
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Source: Chart from freestockcharts.com
The stock is trading below the 20-, 50-, and 200- Day Moving Average (Daily Chart). The stock remains in a down-trend, however the vertical line represents the point where I think the stock is likely to recover. I believe the floor on the stock is at approximately $84.00 per share.
Notable support is $74.00, $80.00, and $84.00 per share.
Notable resistance is $90.00, $95.00, and $100.00 per share.
Street Assessment
Analysts on a consensus basis have very reasonable expectations for the company going forward.
Growth Est | MCD | Industry | Sector | S&P 500 |
Current Qtr. | 0.00% | 26.30% | 9.20% | 9.40% |
Next Qtr. | 2.40% | 199.50% | 29.60% | 15.00% |
This Year | 0.80% | 36.70% | 30.10% | 7.10% |
Next Year | 8.90% | 14.20% | -14.80% | 13.10% |
Past 5 Years (per annum) | 12.60% | N/A | N/A | N/A |
Next 5 Years (per annum) | 8.84% | 15.57% | 14.15% | 9.10% |
Price/Earnings (avg. for comparison categories) | 16.71 | 16.47 | -6.5 | 12.49 |
PEG Ratio (avg. for comparison categories) | 1.89 | 1.21 | 0.33 | 1.34 |
Source: Table and data from Yahoo Finance
The company shows reasonable growth as analysts on a consensus basis have a 5-year average growth rate forecast of 8.84% (based on the above table).
Earnings History | 11-Dec | 12-Mar | 12-Jun | 12-Sep |
EPS Est | 1.3 | 1.23 | 1.38 | 1.47 |
EPS Actual | 1.33 | 1.23 | 1.32 | 1.43 |
Difference | 0.03 | 0 | -0.06 | -0.04 |
Surprise % | 2.30% | 0.00% | -4.30% | -2.70% |
Source: Table and data from Yahoo Finance
The average surprise percentage is -1.1% analyst forecast earnings over the past four quarters (based on the above table). I don't think this is a long-term trend, earnings management is likely to result in McDonald's beating on quarterly estimates eventually.
Forecast and History
Year | Basic EPS | P/E Multiple |
2003 | $ 1.18 | 21.04 |
2004 | $ 1.81 | 17.71 |
2005 | $ 2.06 | 16.37 |
2006 | $ 2.87 | 15.46 |
2007 | $ 2.02 | 29.16 |
2008 | $ 3.83 | 16.24 |
2009 | $ 4.17 | 14.97 |
2010 | $ 4.64 | 16.54 |
2011 | $ 5.33 | 18.82 |
2012 | $ 5.31 | 16.49 |
Source: Table created by Alex Cho, data from shareholder annual report, and price history is from Yahoo Finance.
The EPS figure shows that throughout the 2003-2006 period, the company was able to grow earnings. In 2007 the company had reported a $1.67 billion impairment charge (loss of goodwill). During 2007 the company grew top line revenues despite the impairment charges. The company was able to grow through the great recession which implies that the business has competitive strengths, and is non-cyclical. After the great recession the company continues to grow earnings.
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Source: Table created by Alex Cho, data from shareholder annual report
The restaurant industry has an income-elastic demand of 1.61. This means that a 1% improvement in income is likely to result in a 1.61% improvement in spending on restaurant services as a portion of a personal budget.
In 2010 income GDP per capita worldwide was at $7,329, by 2020 this is forecasted to be at $9,388. Income on a world-wide basis is likely to grow by at least 28% over the decade, this improvement in income will make for a larger number of restaurant visits, and will contribute to McDonald's growth going forward.
So as long as emerging market demand continues to improve, the company will generate reasonable returns over a 5-year time span based on the forecast below.
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Source: Forecast and table by Alex Cho
By 2017 I anticipate the company to generate $8.79 in earnings per share. This is because of earnings growth, improving global outlook, and earnings management.
The forecast is proprietary, and below is a non-linear chart indicating the price of the stock over the next 5-years.
(click to enlarge)
Source: Forecast and chart by Alex Cho
Below is a price chart incorporating the past 10 years and the next 6 years. Detailing 16 years in pricing based on my forecast and price history on December 31st of each year.
(click to enlarge)
Source: Forecast and chart created by Alex Cho, data from shareholder annual report, and price history is from Yahoo Finance.
Investment Strategy
MCD currently trades at $87.58. I have a price forecast of $105.66 for December 31st 2013. The stock is below value, and I anticipate the vast majority of the price recovery will happen in the second half of 2013.
Short Term
Over the next twelve months, the stock is likely to appreciate from $87.58 to $105.66 per share. This implies 20.6% upside from current levels. The technical analysis indicates a trend reversal towards the second half of the year. While the previously mentioned price forecast using fundamental analysis further supports the assessment.
Investors should buy MCD at $87.58 and sell at $105.66 to pocket short-term gains of 20.6% in 2013.
Long Term
The company is a great investment for the long-term. I anticipate MCD to deliver upon the price and earnings forecast despite the risk factors (missing analyst expectations). MCD's primary upside catalyst is international expansion, rising incomes of the middle class, and earnings management. I anticipate the company to deliver upon my forecasted price target of $160.64 by 2018. This implies a return of 83% by 2018. When factoring back in the dividends (based on the table below) the company will generate a combined return of 121%. This rate of return is exceptional considering the low-level of risk (5-year beta of 0.4).
Year | Dividend Yield @ $87.58 per share | Cumulative Total |
2012 | 3.47 | 3.47 |
2013 | 4.164 | 4.164 |
2014 | 4.858 | 9.022 |
2015 | 5.6908 | 14.7128 |
2016 | 6.6624 | 21.3752 |
2017 | 7.80056 | 29.17576 |
2018 | 9.13304 | 38.3088 |
Source: Forecast and table by Alex Cho, dividend data from shareholder annual report
A higher yielding investment opportunity albeit having higher risk is to buy the Jan 17, 2015 calls at the $95.00 strike. The call premiums are at $4.24. The price forecast for the end of 2014 is $114.94. The rate of return if the calls expire at a $114.94 is 370%.
MCD has a market capitalization of $87.9 billion; the added liquidity makes this an investment opportunity appropriate for larger institutions that require added liquidity.
Conclusion
Investors should remain optimistic on McDonald's as it is likely to outperform the Dow component going into the second half of 2013.
The conclusion is simple: buy McDonald's on long-term growth.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
