McDonald's: Innovative, Recession Resistant, and a Steady Grower

Much has been written about McDonald's (MCD) being a recession-resistant stock. You can read about it here, here, here, here, and here for example.

There is some truth to the thesis. After all, people still need to eat, so doesn't it make sense to be eating at an affordable place like McDonald's when times are tough. In the same manner, Wal-Mart (WMT) has proven to be recession-resistant. People still need to 'buy things' but instead of shopping at the more expensive retail firms, or eating out at more expensive restaurants, the McDonalds and the Wal-Marts are likely increasing their market share in these recession-ridden times.

With that in mind, I wanted to briefly look at McDonald's and see if it truly was an investment, that I personally believed, was worth considering even in today's turbulent stock market.

First of all, what about the latest quarterly result? On April 22, 2009, McDonald's reported 1st quarter 2009 results. Revenue did dip to $5.08 billion from $5.61 billion the prior year. Net income came in at $979.5 million, or $.87/share, ahead of analysts expectations of $.82/share. However, revenue failed to meet expectations of $5.23 billion. However, same-store sales worldwide grew 4.3%. It is difficult to know how same store sales can rise and overall sales can dip, unless factors such as currency exchange rates are affecting the total.

The latest numbers for the United States continue to be strong as April, 2009, 'same-store sales' grew 6.9% as reported. The article does relate that McDonald's same-store sales grew even faster in Europe at 8.4% and came in at a 6.5% increase in Asia/Pacific. However, China apparently is underperforming this rate as things continue to slow there in the face of a growing economic correction.

Longer-term, reviewing the Morningstar.com '5-Yr Restated' financials on MCD, we can see that revenue has been steadily growing from $19.1 billion in 2004 to $23.5 billion in 2008. In the trailing twelve months, McDonald's has experienced a slight dip in revenue to $23.0 billion. Earnings, except for a dip from 2007 to 2008, have grown steadily from $1.79/share in 2004 to $2.83/share in 2007--dipping to $1.98/share in 2008--and rebounding to $3.76 in 2008 and $3.83/share in the TTM.

In addition, the company pays a dividend which they have rapidly and consistently increased from $.55/share in 2004 to $1.63/share in 2008 and $1.75/share in the TTM. In terms of outstanding shares, the company had 1.27 billion shares outstanding in 2004, and has been gradually decreasing this amount to 1.146 billion in 2008 and 1.136 billion in the TTM.

Free cash flow remains solidly positive although this has slowed slightly in the TTM. MCD reported $2.6 billion in free cash flow in 2006, $2.93 billion in 2007, $3.78 billion in 2008 and $3.43 billion in the TTM.

Insofar as the balance sheet is concerned, Morningstar reports this company with $1.98 billion in cash and $1.47 billion in other current assets. This total of $3.45 billion easily covers the $2.21 billion in current liabilities reported. In terms of the current ratio, this yields a ratio of 1.56. McDonald's also has a significant $12.9 billion in long-term liabilities on its books, but with the ample cash and current assets, the positive free cash flow, and its record of growing its revenue and earnings, this doesn't seem to be a significant burden for them.

In terms of valuation, looking at the Yahoo 'Key Statistics' on MCD, we can see that this is a large cap stock with a market capitalization of $59.3 billion. The trailing P/E is a very reasonable 13.98 with a forward P/E of 12.86. The PEG ratio (5 yr expected) suggests that even with this relatively low P/E, the company is a bit richly priced with a PEG of 1.56.

Using the Fidelity.com eresearch website for some additional valuation numbers, we find that the Price/Sales ratio (TTM) works out to 2.60 compared to the industry average of 1.70. The company is also slightly less profitable than its peers when viewed from the perspective of Return on Equity (TTM) with MCD coming in at 32.35% vs. the industry average of 47.67. However, their return on assets, and their return on investment handily outpace their peers.

Finishing up with the Yahoo information, there are 1.11 billion shares outstanding with 1.09 billion that float. As of 4/27/09 there were 13.43 million shares out short, representing a short interest ratio of 1.4 days or 1.2% of the float---hardly the numbers I would look for that might cause a 'squeeze'.

Finally, with the $2.00 forward dividend rate, the company pays a significant dividend yielding 3.7%. There appears to be good coverage for this dividend with a payout ratio of 46%. The last stock split was a 2:1 split just about ten years ago on March 8, 1999.

What does the chart look like?

Reviewing the 'point & figure' chart on McDonald's, we can see that the company experienced a sharp rise in its stock price between May, 2005 and August, 2008, when the stock rose from $25 to $65. The stock dipped briefly to the $45 level in October, 2008, then fought back, but has struggled a bit since hitting the $63 level three times in December 2008 and January 2009. I would have to say I am less than enthusiastic about the technical appearance of this chart--at least from my amateur perspective.

click to enlarge

In conclusion, McDonald's is indeed a recession-resistant company. They are continuing to show positive same-store growth and appear to be taking a bigger market share from its competitors. Unfortunately, the strong dollar is depressing their financial results--due to exchange rates when results are reported in dollars--and they are feeling the pressure from their multinational business as many such corporations are experiencing today.

Due to what appears to be brilliant management, this gigantic restaurant chain is reinventing itself, adding salads, healthier items and a coffee bar to many of its newly named 'Cafes'.

This company has been a steady grower from well before 2004 and continues to produce solid results. However, valuation is a tad rich in terms of P/E relative to growth, Price/Sales ratios are also a bit rich relative to other companies in the same industry, and the chart appears a bit 'tired'. Clearly, I am not the first amateur to think about buying McDonald's stock. But regardless of all of that, I do like this company, like their ability to innovate and produce a consistent product, and like their steady revenue growth, earnings growth, dividend growth, decline in outstanding shares, and solid balance sheet.

You could do worse in a market like we have today.

By the way, McDonald's was trading at $53.50, down $.069 or .13% on Friday.

Disclosure: I do not own any shares of McDonald's currently but some of my immediate family members do own small lots of shares in their own accounts.

Comments

[Adina Genn:]

Both small and large companies can learn a lot about effective leadership by modeling themselves after McDonald's, regardless of whether they are in the food business, as I learned in co-writing my book, "Everything I Learned About Business I Learned at McDonald's" (McGraw-Hill).

May 17 11:38 AM