Not Even McDonalds Is Safe

I have to believe the slowing consumer is being priced across the market at this point, when I see McDonald's (MCD) taking a nose dive. This was my concern going into earnings season - that estimates for 2008 will need to be driven down as analysts are way too optimistic and companies will be reducing estimates. It looks like it has happened even in advance of the actual earnings season which only begins in earnest this week. This is actually a good thing as it leaves less room for disappointment.

Let me say, after just posting how much I dislike restaurants I disagree with this call on McDonald's . I do not follow it closely (it is not a high growth story per se, nor a sector I like), but with the stock approaching its 200-day moving average this is a blue chip stock hitting on all cylinders, and in my opinion will be a WINNER in a slow growth economy. This is something that the analyst on Friday had wrong. Just like when I wrote "Target (TGT) Shoppers Turning into Walmart (WMT) Shoppers," those with low prices will be winners in a slow growth economy. In the same way that Costco (COST) is winning over the high-end consumer, I can see Walmart benefiting, and I can see the exact same parallel in McDonald's (MCD) as casual dining loses some customers who instead of eating out once or twice a week will instead be going fast food ('substitution').

The stock is in the $53s, down from $63 a month ago. If this were the sector of the market (mega cap stocks) I was focusing on, then I'd be very interested in what is happening here. More importantly, we are now reaching the point where analysts are just being simplistic and saying, "Well it lives, and breathes, it must be downgraded since the consumer is slowing." This is not rational thinking, as things are a bit more complex than that. There is no mention of the company's international growth, the baristas, or its dominance in "on the run" breakfasts.

Shares of McDonald's Corp (MCD) fell nearly 7 percent on Friday, leading a downturn in many other U.S. restaurant stocks, amid concerns a U.S. recession could hurt even lower-priced restaurants.

"With gas (gasoline) prices at all-time highs, the discretionary income of the consumer is shrinking," said William Lefkowitz, options strategist at vFinance Investments. "Companies that depend on the consumer to spend money will get hurt."

Coming into Friday, the stock traded at a multiple of 20 times estimated 2008 earnings, the third highest multiple in the Dow Jones Industrial average (^DJI - News). It trailed only Coca-Cola Co (KO) and Procter & Gamble (PG), two stocks that have been boosted by their defensive status as consumers generally buy things like soap and soft drinks even during a recession.

"The P/E (price-to-earnings ratio) is back to a level where for me it's a little bit expensive," Janna Sampson, co-chief investment officer at Oakbrook Investments in Lisle, Illinois, said. "That said, relative to some of its competitors, I'd have to say its P/E still looks reasonable." Sampson's company holds about 205,000 McDonald's shares.

On Friday, Friedman, Billings, Ramsey restarted coverage of McDonald's at a "market perform" rating with a 12-month price target of $53. But analyst Howard Penney said McDonald's should be able to sustain U.S. same-store-sales growth in the first half of 2008. "We believe that McDonald's premium valuation reflects the company's ability to post continued positive same-store-sales trends," Penney wrote in a research note.

Some analysts were also skeptical of the notion that consumers would stop eating at McDonald's in a down economy. Morningstar analyst John Owens said:

For the most part, fast food seems to be becoming more of a consumer staple. That was the case in previous downturns in the consumer cycle.

On that last point, I agree. Now that it's cool to say everything stinks because the consumer is dead, doesn't mean it's correct in every piece of the economy. Once again HERD MENTALITY at it's best on the Street. I'd be more concerned with the valuation in P&G at this point. Or is the slowing consumer going to stop buying toilet paper and switch to tree leaves?

I'll check back in a year to see how things worked out, and to see if this was a decent entry point ($53) for those so inclined. For our view point, the good thing is that perception and reality are now in alignment. The perception throughout the fall, and most of the early winter was this is nothing to be worried about - it's all contained. Now we've swung to another extreme where everything must be worried about. This is good since it's all part of the process.

Disclosure: The author has no position in MCD.

Comments

[John Strong]

Well writen-I totally agree