McDonald's (MCD) has been known as the best of breed fast food chain for as long as I can remember. In the past, owning McDonald's stock has meant some pretty "juicy" returns over the long run, but can these types of returns stay? Increased competition from other fast food chains could be reducing McDonald's former domination in the fast food marketplace. Nevertheless, McDonald's rarely disappoints, and does tend to be more innovative and in touch with the fast food consumer.
Do the Numbers Add Up?
- Growth - McDonald's is in great shape financially, partially due to its excellent management team. McDonald's currently has large amounts of cash, and very low liabilities. For example some recent financials show a seven-year revenue growth rate of 4.4%, an EPS growth rate of 14.8%, and dividend growth rate of 23%. McDonald's also has growth opportunities particularly overseas in the coffee market, with the expansion of the McCafe's. Despite these decent numbers, McDonald's growth is also something that worries me, as explained below under risks.
- Dividend - McDonald's currently yields 3%, which is an above-average dividend. In addition to the dividend, McDonald's also spends over $8 billion on share buybacks.
- Valuation - McDonald's currently trades at a Price-to-Earnings ratio of around 18, which values it fairly based on similar companies and past P/E ratios. For further evidence, MCD's current PEG ratio is about one, meaning it is priced perfect in relation to its growth rate. (All statistics courtesy of Value Line Investment Survey).
- Increased Competition - Increased competition, particularly from YUM Brands' (YUM) Taco Bell has been hurting McDonald's of late. YUM owns Taco Bell, Pizza Hut, and KFC, but it's Taco Bell who has been seeing significant growth. Taco Bell's new product innovations, store modeling, and marketing campaigns for its new Doritos (PEP) Locos Tacos have had a significant effect on McDonald's. Taco Bell also tends to have later hours than McDonald's, capitalizing on the late-night crowd.
- Inflation - Inflation is obviously a huge concern for McDonald's, as increases in costs for food and supplies will have a significant effect on its bottom line. The dollar menu is a significant portion of its sales, yet margins are extremely low. The dollar menu is something that will eventually have to be exceeded by the "Value Menu" in all locations.
- Over Growth - It is unlikely that growth will continue at the rate McDonald's has grown in the past. Many of McDonald's new store opportunities have already been exhausted. McDonald's has expanded to nearly every market imaginable, leaving little room for significant growth similar to past performances. As a result, it is unlikely the dividend will continue to grow at such a rapid pace.
McDonald's is definitely the best of breed in this industry, having the most recognizable storefront, as well as the highest revenues and some of the best real estate locations throughout the world. There is however some concern over increased competition and overall valuation for the company right now. McDonald's has taken a slight pullback from its highs, but nevertheless I recommend keeping an eye on this one for a while before making a purchase. Over the long term McDonald's may be a worthwhile investment for conservative investors, but I recommend waiting for a better entry point.