Seeking Alpha
ETF investing, dividend investing, long-term horizon, value
Profile| Send Message| ()  

The purpose of this article is to discuss the attractiveness of ("McDonald's Corporation (MCD)") as an investment option. To do so, I will review MCD's most recent quarterly and annual statements, the company's and competitor's recent performance, and trends within the industry to attempt to determine where the stock may be headed from here.

First, a little about MCD. MCD operates and franchises McDonald's restaurants in the global restaurant industry, doing business in over 100 countries around the world. Most famously known as a burger joint, the company sells a variety of products in its fast food chains, such as chicken products, soft drinks, french fries, and numerous other items. A significant portion of MCD's restaurants are franchised or licensed, providing steady revenue streams for the company. MCD had been the largest restaurant chain worldwide for years, only to be recently overtaken by Subway in terms of total number of locations. MCD competes with other burger chains such as Burger King and Wendy's, with local and regional chains such as Sonic and Five Guys, as well as with fast food chains of other genres like Subway and Chipotle. MCD operates in an extremely competitive environment, yet the stock has held up relatively well. Currently, MCD is trading at $99.77/share and pays a quarterly dividend of $.77/share, which translates to an annual yield of 3.1%.

Recently, the stock has performed strongly along with the broader market. Year to date the stock is up around 13%, excluding dividends, and over the past 52 weeks the stock is up over 11%, also excluding dividends. Given this performance, coupled with intense industry pressure and rising input costs, I want to review MCD's recent financial statements to see if the stock still has room to move higher.

There are plenty of reasons to be cautious about MCD. For one, the trend towards healthier eating is not going away any time soon, and MCD is synonymous with saturated fat and processed meats. The company is also facing an increasingly saturated U.S. market, as well as increased competition from multiple areas. Some of this competition is from the development, and success, of newer chains such as Chipotle and Five Guys, while other competition is a direct result of MCD's aggressiveness. For instance, the company began competing head-on with the likes of Starbucks and Dunkin Donuts when it established the "McCafe" and began promoting a value-priced coffee and a variety of hot and cold beverages. Finally, MCD faces volatile business climates in many corners of the world as consumers and governments fluctuate between pro and anti American mindsets, as well as their willingness to accept the health risks a regular diet of MCD's food is sure to bring about.

However, there are also reasons to be optimistic. While revenues have been slowing, the company's most recent 10-Q shows that revenue at both company-operated restaurants and franchised restaurants grew in a quarter over quarter comparison. While the growth is minimal (less than 1%), growth is still growth, something I do not take lightly given the soft consumer spending environment. Net income also increased slightly in 2013, in a first quarter comparison to 2012, as the company aggressively cut costs, brought down its interest expense, and raised prices on a few of its staple items. Again this rise is slight, a fraction of a percent, but the company is still faring better than many of its competitors.

There are also some large-scale reasons I still like MCD. Growth for a business this size is always challenging, but MCD continues to expand, both in the U.S. and abroad. All lines showed an increased number of restaurants, including conventional outlets, franchises, and foreign affiliates. MCD saw an increase of 3% in system wide restaurants in 2013 over 2012, and this will bode well as MCD continues to build its brand, especially overseas, and take share away from its nearest competitors. With growth in sales continuing, there is no evidence as of yet to suggest that additional outlets are cannibalizing existing store sales. While this may be a risk going forward, it is worth noting that MCD's is seeing its fastest growth in the APMEA region, an area that is certainly not saturated with outlets and represents an increasingly important growth region for the company. According to the 2012 annual report, MCD saw an increase of almost 6%, year over year, sales growth in this region. With softer sales in its core markets of North America and Europe, the company's ability to succeed in this region is essential, and so far it appears to be doing so.

Another unrelated reason I like MCD has to do with its dividend history. MCD's has a long history of paying, and increasing, its dividend, and most recently the company hiked the payout by 10%, continuing to give investors a steady stream of revenue. The trend over the last year to year and a half has been heavily weighted towards dividend payers and, without a massive spike in bond yields, I expect this trend to continue as investors are still seeking safety and low volatility. MCD's certainly has both, with a global presence and a beta of just .35, which indicates the stock is much less volatile than the market as a whole.

One thing I want to see the company move away from is its increasing emphasis on trying to add "healthy" items to its menu. Now, this may seem counter-intuitive to a lot of people because healthy foods are definitely growing in popularity and consumers are increasing looking for nutritious meals, aside from just being fast. However, my contention is that consumers are not going to MCD for a healthy meal, as much as society may want them to. While consumers by and large are indeed becoming more health conscious, those are not MCD's core customers. In fact, previous attempts to make the menu more nutritious have not met much success. For example, when MCD began offering premium salads on its menu, many analysts saw this as a major step for MCD in luring back a younger and health savvy demographic. However, having salads on the menu did little to change customer's appetites. In fact, salads accounted for only 2-3% of total sales, according to MCD's CEO in a recent investor conference. There can be multiple reasons for this, but I imagine that people who are interested in eating a salad for lunch or dinner simply do not consider MCD as an alternative. Whether the salad is even good for you is beside the point. The point is MCD will need to do more than simply add a salad to its menu to convince consumers that its food is fresh and viable in today's market.

I bring this point up because MCD recently spent countless hours on research and testing to develop the "McWrap" to replace its emphasis on burgers. I think this is a mistake. In my opinion, consumers do not go to MCD in search of a chicken wrap anymore than a Starbucks customer goes to Starbucks to order a burger. Now, I am not signaling out the McWrap for any specific purpose other than the fact that it was most recently introduced. MCD does need to continue to innovate and customize its menu, but my hypothesis is that they are doing it in the wrong direction. My previous reference to the addition of salads shows that it has not been wildly successful. I imagine that the McWrap has not been either. I say this because if it was, management would have altered the public already because this is a company that loves to toot its own horn (remember "billions and billions served"?). I contend MCD needs to continue to innovate in ways that make sense to its actual customers, and not politicians or activists who never even eat there. MCD has done well to differentiate itself with localized tastes in global markets, I'm positive it can do so here as well. But as an investor, I want less energy, cash, and other resources to be focused on changing the menu in ways that do not drive sales or value. MCD needs to focus on its core products and on value because there are plenty of other places consumers can purchase a $5 chicken wrap or salad that will not fill you up.

Bottom-line: MCD continues to drive consumers into its restaurants on a global level. Many of its products have been staples in the American diet for some time, and are now becoming standard fare in many corners of the world. The company dominates the fast-food space, with a valuable brand name and a cost advantage over all of its rivals. While competition will continue to increase in the coming years, MCD has as a unique ability to provide fast, tasty, and convenient products to value-seeking customers. With employment numbers improving, that means more consumers are in the after-work commute home searching for a quick, convenient meal. MCD needs to focus on delivering the products these customers want, and not getting caught up in a health battle it surely cannot win. With a growing presence worldwide, and continued dominance in the U.S. market, coupled with a reliable (and rising) dividend, MCD will continue to be an attractive option for patient investors.

Source: McDonald's Can Offer Investors Opportunity By Focusing On Its Core Business