McDonald’s (MCD) has been a fabulous performer over the past five years, more than doubling in value, although it had been flat over the previous five. Why then don’t I want it in my retirement portfolio now, for the next three to five years?
True, it has paid a steadily rising dividend for 33 years now, and as such, is a standard holding in many retirement accounts and pension funds. But at McDonald's’ current dividend payout of 3.30%, it is currently underperforming the ten year Treasury bond yield of 3.49%, and one would need to depend on share price appreciation greater than the rate of inflation (8.5% if you believe John Williams) minus the dividend yield for a positive real return.
By this calculation, you would need share appreciation of 5.2% a year just to equal inflation (even more after taxes). I would wait for a 25% to 30% drop in the share price to start a position in McDonald's, and consider selling any positions now and adding a high yielding stock with better prospects.
It may be difficult for McDonald's to maintain its superb performance with some of the headwinds it will be facing over the next few years. Let’s start with:
Comparable sales growth just dropped 5.3% in February 2011, and dropped 4.8% from a year earlier. It seems clear that the top line growth that has kept McDonald's so profitable has been from continued expansion, and innovative new product lines. In the past few years, it has made lots of money by introducing its premium coffee beverages, capturing market share from Starbucks (SBUX), but that should eventually slack off. Its newest innovation is oatmeal for breakfast, which is an admirably healthy addition to its fast food offerings, but I just don’t see it being as profitable for their franchise as the new premium coffee line has been.
McDonald’s still has big expansion plans, especially in Asia, but same store profitability is crucial to its long range financial health.
What concerns me most are the headwinds McDonald's faces over the next few years from macroeconomic trends, mainly peak oil and accelerating expansion of the money supply.
Gasoline prices just passed the $4.00 mark in California this week, and the trend is clearly up. Even without crude oil supply disruptions and all the uncertainty in the Mideast, this is a depleting resource and new discoveries are not sufficient to replace the known reserves being consumed. Also, developing economies are consuming more and more to expand and satisfy the demands of a growing middle class, so even if developed economies conserve and start consuming less oil, this trend of increasing global demand will not reverse. Add to that the massive money creation around the world, and the nominal price of gasoline and crude oil will continue up as a consequence of monetary inflation.
All this will have multiple effects on McDonald's’ bottom line. First of all, as gasoline prices increase, people will do less driving to restaurants. The price to deliver the ingredients by truck to each franchise will increase. And the resulting increase in commodities prices will have a huge effect on the cost of their menu.
In the last 365 days, the price of corn has increased by 92.5%, the price of coffee has increased by 90.8%, the price of wheat has increased by 61.2%, sugar is up 52.7%, soybean oil is up 49.9%, and live cattle are up by 24.6%. I know that McDonald’s doesn’t sell corn, but ranchers do feed it to cattle, and it’s used to sweeten beverages and desserts. All this will squeeze McDonald’s bottom line, or force price increases at the restaurants.
According to the USDA, beef exports surged by 19 percent in 2010 resulting in the smallest US cattle herd since 1958, while increasing Asian demand for beef has driven US beef exports to their highest level in seven years. This is likely due to the rapidly increasing price of feed grains, so ranchers are slaughtering their herds rather than feeding them, and selling the beef at the currently elevated prices to the export market. But the supply shortage this short term strategy creates will cause beef prices to increase even more a few months from now.
As McDonald’s continues its expansion into Asia, Africa and the Mideast (and increases its debt) it will come head to head with expanding competitors such as Wendys/Arbys Group, Inc (WEN), and Yum! Brands, Inc (YUM) who operate KFC, Pizza Hut, Taco Bell and A&W, and will begin to feel the effects of market saturation as it starts to run out of profitable markets in which to expand.
And I see the continuing global recession causing a decrease in consumer spending on restaurant meals, as more and more families react to higher food costs by eating more of their meals at home.
You certainly could do a lot worse than McDonald's in your retirement portfolio, of course, but my opinion is that McDonald's will underperform the S&P over the next few years, and will underperform the 26 picks in my Ultra-Conservative Portfolio for The Next Three Years. I also believe that it will seriously underperform both silver and gold, which, in my opinion, should form the core of any retirement portfolio for the next three years (and beyond).
Disclaimer: I am not a professional financial planner. I am a macroeconomist with an interest in retirement planning and helping people preserve their life savings from the ravages of mismanaged government policy and corporatism. I believe that following the obvious macroeconomic trends will make you more money than focusing on individual investments and sectors. Today in 2011, the most important trends to follow are the multi year price imbalance in the precious metals market, peak oil, the continual devaluation of the dollar and all fiat currencies, world population growth, baby boomer demographics, the continual decline in the housing market, and the insolvency of the banking/financial/insurance sector. To keep things simple, the goal is to limit the portfolios to no more than ten to twenty individual holdings. Mutual funds, ETFs, ETNs and derivatives of any kind are to be avoided, although physical precious metals funds are necessary to substitute for physical bullion holdings.
Excessive diversification for the sake of diversification may limit your losses but will also limit your gains. Concentration is obviously good if concentrated in the correct areas. Traditional retirement allocations have included both stocks and bonds based on past performance that bonds would often perform opposite to stocks. In the coming few years, I believe that the bond bubble will burst, and stocks will also perform poorly. A portfolio of precious metals, certain commodities, and carefully chosen stocks will outperform. I’m currently avoiding all retailers, bankers and homebuilders based on the current economic conditions.
I would advise any investor at this time to have at least 50% of their investment capital in physical silver and gold bullion to protect against the coming currency collapse. You would need to achieve incredibly high, unrealistic investment returns to compensate for the fact that the US dollar is losing 50% of its purchasing power every 10 years. But since most people are too complacent or find other objections to investing in physical bullion, my model portfolios are designed for use in self directed retirement accounts by those who won’t follow my good advice to purchase physical bullion. All are designed as long term buy and holds with a minimum time horizon of five years. Portfolios should be examined once or twice a year to insure that all holdings are still compatible with current macroeconomic trends, and have not cut dividends. I’m not interested in the many short term trading strategies using these same trends that may produce higher returns, as these are time consuming to actively manage, and assume more risk. I’m interested in helping the individual investor who prefers to manage his own assets, while getting superior total return without wasting money on a professional who gets paid no matter how poor the results. Do not use this as investment advice. Your own portfolio should be customized for your individual situation. Always consult a financial professional, but avoid the 98% of financial professionals that don't think for themselves, and don't have a thorough knowledge of the fundamentals and long term trends in the precious metals markets, peak oil, and other macroeconomic trends.