McDonald's (MCD) shares have slipped a bit lately, purportedly on the weaknesses of the eurozone, but given the fact the stock is overvalued some 30% on a discounted cash flow basis, I see no reason for alarm. After all, the economic turmoil in Europe has hit most stocks that derive significant percentages of revenue from eurozone member states. McDonald's gleans some 40% of its revenue stream from Europe. Of greater importance--the fundamentals of the company, so let's have a look, as we compare McDonald's with close rival Yum! Brands (YUM).
McDonald's has a market cap of about $90 billion and trades at around $88.00. The price-to-earnings ratio is 16.50 and the price-to-earnings-growth ratio is 1.62, followed by a price to book of 6.18. As restaurants go, these are excellent numbers, besting, for example, Yum! Brands, which reports 20.44 for price to earnings, 1.44 for price to earnings growth and 14.06 as its price to book. Yes, Yum! Brands' price-to-earnings-growth ratio is slightly better but when viewed in the context of its price-to-earnings ratio...well, you understand!
McDonald's has a solid return on equity of 38.2%, but is eclipsed by Yum! Brands at 73.9%. Quarterly year over-year revenue and earnings growth for McDonald's is reported at 7.% and 4.8% respectively, while Yum! brands reports 13.1% and 73.5% respectively. This prompted me to turn to the income statements for a full year-over-year view. Annual year-over-year revenue for McDonald's came in at 12.17% compared with Yum! Brands at 11.31%. Earnings growth evened out considerably, but Yum! Brands still edged out McDonald's slightly. McDonald's shows earnings growth of 11.26% while Yum! Brands came in at 13.90%. Both stocks provide shareholders a dividend. McDonald's yields 3.1% with a payout ratio of 49% and Yum! Brands yields 1.7% with a payout ratio of 34%.
McDonald's is not the only restaurant stock to lose ground recently. Chipotle Mexican Grill (CMG) took a bigger hit. What intrigues me is the fact that Chipotle Mexican Grill has a comparatively tiny footprint in Europe. Its stores are confined to England and Canada. This raises a question about the European economic crisis being the cause for the slip in McDonald's share price. There are certainly other factors that might explain Chipotle Mexican Grill's slip. It has an astronomical price to earnings of 53.89 and from a discounted cash flow perspective, is overvalued by around 78%.
McDonald's Chief Financial Officer Peter Bensen is not blaming the European crisis. Mr. Bensen has a different take on it. Bensen's argument may find support in the consumer confidence index. Eating out is, after all, discretionary spending. As consumer confidence falls and belts are tightened, eating out is often the first option consumers use as a cost-cutting measure. So what is the outlook for McDonald's?
Recently, I spent some time in Cagayan de Oro, Philippines, a city of some 600,000. There are four McDonald's franchises and all appear to do a robust business. You may find it interesting to know that it costs less to eat at McDonald's there than it does in the states. After puzzling over this, I realized it was labor costs that made the difference--$0.50 per hour there versus $7.50 per hour in the U.S.
McDonald's does an excellent job of insuring that its international franchises tow the line. The food, the physical environment and the quality is indistinguishable from a stateside franchise. The one exception; being able to order fried chicken, spaghetti and steamed rice in addition to the regular fare, a concession to local tastes. While known affectionately in the U.S. as Mickey D's, Filipinos refer to it as McDo's. I also patronized a couple of other U.S. franchises and can't offer such a positive report. Of course, what interests readers is the efficacy of an investment in McDonald's. McDonald's global footprint makes it less vulnerable to the economic circumstances of a particular region and, in fairness, the same can be said for Yum! Brands, which has actually outperformed McDonald's in recent weeks. Chipotle Mexican Grill, however, is largely at the whim of U.S. consumers.
The restaurant industry seems to be weathering economic conditions reasonably well. Of the stocks we have discussed here, McDonald's has my vote. While there is a case to be made for Yum! Brands, Chipotle Mexican Grill is just too expensive in my opinion. The $380 cost per share is a turn-off, not to mention the price-to-earnings ratio of 52.26. Chipotle Mexican Grill's price to earnings growth ratio is acceptable at 1.90 but price to book is an appalling 10.21, something I just can't get my head around. It's a cinch no one can regard its return on equity, quarterly year-over-year revenue and earnings growth as nothing short of admirable. Those numbers come in at 22.75%, 25.8% and 35.1% respectively. Enviable too is the debt to equity and current ratios, which are reported at 0.31 and 4.43, but Chipotle Mexican Grill does not pay a dividend.
In summary, McDonald's has longevity (founded in 1940), the lowest beta of the group at 0.29, and offers the highest dividend yield. Over the past five years, McDonald's has consistently beat the S&P 500 (SPY). Yum! Brands and Chipotle Mexican Grill have ailed to meet that challenge. Additionally, McDonald's is the least overvalued on a discounted cash flow basis. I recommend buying McDonald's now and holding for the long term.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
