What I Like About McDonald's

As one of my basic strategies for dealing with my investments and managing my cash and equity balances, I utilize predetermined sale points for all of my holdings both on the upside and downside after an initial purchase. Sales on appreciation are considered "good news" and generally result in a purchase of a new holding. This is contrasted with sales on the downside, which I refer to as "bad news" signals that result in a shift from equity into cash.

Earlier Wednesday my holding in Walgreen (WAG) reached a first appreciation target--a gain of 30% in stock price after an initial purchase and I sold 1/7th of my holding. I purchased 77 shares of Walgreen in my Trading Account on March 27, 2009, at a cost basis of $26.73/share. I sold 11 shares of Walgreen Wednesday at $34.75 for a gain of $8.02 or 30% since purchase. Since I currently only hold 6 positions, well under my maximum of 20 holdings, this sale on "good news" generated a purchase signal for me, and I added a new position into my trading account.

Recently I have been refining my purchases of positions trying to address the question of not only what and when to buy but to deal with the matter of 'how much'? This question became apparent when my portfolio, during the worst part of the correction, dipped to a minimum of 5 holdings. As these occasionally needed to be sold on losses, and yet reflecting my own desire to maintain a minimum of 5, I needed to address the problem of replacing losing holdings with similarly sized holdings in spite of their sale on 'bad news. Initially I chose to replace them with holdings 50% of the average of the other positions. Subsequently I have decided that 80% or 4/5 of the size of the remaining holdings made reasonable sense to me.

However, with a shrinking position size, conversely I needed some approach that would enable me to increase the size of these downsized holdings as the market improved so that new positions would be more 'normal' in value. Thus, I have chosen to add new holdings at a level of 125% of the value (5/4) of the other positions held in the portfolio. You can see that as a market firms, my new positions will continue to grow in size; when the market is very weak, my replacement holdings will diminish in value.

With my buy signal in hand, I chose to purchase 52 shares of McDonald's Corp (MCD) at a price of $56.18. I recently reviewed this company but would like to touch on some of the updated financial underpinnings to this decision. Unfortunately for me I purchased shares just before the Fed announced its decision to leave short-term interest rates unchanged at near zero, but commented that economic activity had "picked up" since the last Fed meeting in August. As should be expected, the skittish market understood good news to be bad news and sold off shares. Somehow, any comment that things had "picked up" was enough to convince an inflation bear that interest rates would be heading higher soon. Although there appears to be little in the announcement to justify that assessment.

In any case, McDonald's closed at $55.54, down $.27 or .48% on the day, a bit under my own purchase price at $56.18.

Much has been written about McDonald's being "recession-resistant". We do know that the recession has hit upscale restaurants hard. Recently The Motley Fool labeled McDonald's as "recession-resistant". Intuitively, I view McDonald's as the high-quality, clean-store, good-value and consistent product offering that also represents comfort foods in this rather uncomfortable time of steep unemployment numbers and economic slowing.

But let's get back to McDonald's and why I like it as an investment.

The latest quarterly report came in July 23, 2009 as reported. The company's earnings actually dipped to $1.09 billion or $.98/share down from $1.19 billion or $1.04 billion in the year ago period. Revenue would have actually climbed 4% except for currency fluctuations. The company beat expectations of earnings of $.97/share (they reported $.98) but missed expectations on revenue of $5.7 billion (they reported $5.65 billion).

Interestingly, it was a strong dollar that led to adjustments in revenue. When local currency remains stable and the dollar soars, each unit of foreign currency means less dollars reported. If the converse is true, then global revenue should be increasing in the next report due to dollar weakness. Of course, I am not a currency expert, but it could make one wonder. In fact as this article noted:

Stifel Nicolaus & Co. analyst Steve West told investors that the August results were worse than anticipated, but he expected further benefits in foreign exchange rates would help McDonald's overcome any weakness in the monthly metric.

However, the company continues to do well globally. These same-store sales results are reported in local currency, and represent consumer interest in the product. As reported:

Same-store sales - or those at outlets open at least 13 months -- rose 4.8%, including a 3.5% rise in the U.S. Europe was up 6.9% and the Asia/Pacific, Middle East and Africa rose up 4.4%.

Longer-term, except for the recent dip in revenue, the "5-Yr Restated Financials" on Morningstar are impressive. Revenue has climbed from $19 billion in 2004 to $22.5 billion in the trailing twelve months (TTM). Earnings have increased from $1.79/share in 2004 to $3.77/share in the TTM. The company pays a nice dividend and has grown it from $.55/share in 2004 to $1.88/share in the TTM. The company appears to have a reasonable cushion on its dividends with a payout ratio of 50%.

Outstanding shares have been held steady with 1.27 billion in 2004, declining to 1.13 billion in the TTM. Free cash flow continues to be strongly positive with $2.6 billion in 2006 in creasing to $3.6 billion in the TTM.

The balance sheet appears reasonable with $3.6 billion in cash and other current assets compared with the $2.8 billion in current liabilities. The company does have significant long-term debt reported at $13.1 billion.

Checking the Yahoo "Key Statistics" we can see that this is a 'large cap' stock with a Market Capitalization of $60.61 billion. The trailing p/e is 14.72 and the p/e is moderate at 14.72. The PEG is a tad rich at 1.59.

There are 1.09 billion shares outstanding and only 10.28 million shares out short representing 1.3 trading days of volume (the short ratio). The company pays a forward dividend of $2.00/share yielding 3.6%. The last stock split was more than 10 years ago, a 2:1 split on March 8, 1999.

Taking a quick look at a 'point & figure' chart from StockCharts.com, we can see that the stock moved strongly higher from $25.00/share in June, 2005, to a high of $64 in August, 2008. Over the past year it has traded in a tight range between a low of $45 and $62. It appears to have found a new level of support and does not appear over-extended.

To summarize, my Walgreen shares hit a first partial sale point on the upside triggering a 'buy signal' in my own trading strategy. The small portion of Walgreen was sold and a new position in McDonald's was established at a slightly larger size than my other positions as was indicated.

I like McDonald's both from its well-established brand, its ability to innovate in a mature market, its reasonable valuation and its solid dividend. I believe we are still working ourselves out of a rather severe recession and that the value both in the stock and the product it sells will play out well for me. Now, if I can only avoid super-sizing any fries, I shall not have to worry about my ever-struggling diet.

Disclosure: The author holds positions in MCD and WAG

Comments

[John Gordon:]

While analyst mentioned the MCD same store sales metric, additional metrics are needed for McDonald's to more accurately track it.

Over 70% of its profit comes from franchise operations (royalties, franchisees opening new sales and surviving) and from its real estate operations (rents, leases and buying/selling property).

So...while same store sales is important, additional drivers are present. Someday, perhaps, we can develop a new analytical framework for companies beyond just bumper sticker phrases.

John A. Gordon
Chain Restaurant Earning and Economics Experts
pacificmanagementconsu...

Sep 24 09:15 AM

[borisb:]

MCD last peak was on June 3, 2009.. since then it has downtrended for 71 days to last weeks monday low point of $53.88. Yesterday gs raised estimates and reiterated $65 goal. The shares need a catalyst to reverse the downtrend.

Sep 24 01:27 PM

[Robert Free...:]

Excellent point. Probably all of the rest of the questions including royaltees, rents, leasing, etc. in some fashion are meaningless if they can't sell burgers. So the same-store-sales numbers, while easily manageable for an amateur like me, still are quite significant but they are not the whole story as you quite astutely point out. Thanks for taking the time to comment!


On Sep 24 09:15 AM John Gordon wrote:

> While analyst mentioned the MCD same store sales metric, additional
> metrics are needed for McDonald's to more accurately track it.<br/>
>
> Over 70% of its profit comes from franchise operations (royalties,
> franchisees opening new sales and surviving) and from its real estate
> operations (rents, leases and buying/selling property).
>
> So...while same store sales is important, additional drivers are
> present. Someday, perhaps, we can develop a new analytical framework
> for companies beyond just bumper sticker phrases.
>
> John A. Gordon
> Chain Restaurant Earning and Economics Experts
> pacificmanagementconsu...

Sep 24 03:10 PM

[Robert Free...:]

The 'point & figure' chart shows possibly a bit of a different picture. there appears to be a narrowing in the price fluctuation with lower highs and higher lows....almost a 'wedge formation' if that is the correct analysis....to me it appears to be 'consolidating' in price and likely to make a move higher or lower more convincingly in the near future.

Again, that is my 'amateur' assessment.

Thanks for commenting and taking the time to write here.


On Sep 24 01:27 PM borisb wrote:

> MCD last peak was on June 3, 2009.. since then it has downtrended
> for 71 days to last weeks monday low point of $53.88. Yesterday gs
> raised estimates and reiterated $65 goal. The shares need a catalyst
> to reverse the downtrend.

Sep 24 03:13 PM

[THofler:]

I have built a small position in MCD over the last 4 or 5 months with a basis of $54.35/sh. Cramer thinks it is a solid long term holding, but will likely underperform other retailers if the market continues with more bullish surges. I'll stick with solid.

Good news today! Management just announced a 10% dividend boost to $0.55/qtr. As the author notes, the dividend growth is very impressive. Though in the long run div. growth can't outstrip earnings growth.

Sep 25 01:21 AM