What Makes McDonald's an Excellent Play?

As I mentioned in my post about a deteriorating consumer environment, I think McDonald's is shaping up to be an excellent play. Earlier in the year, McDonald's (MCD) was touted as a "weak dollar" play due to its extensive international exposure and the massive currency gains the company was posting from exchange rates worldwide. However, things have changed in six months time. Nowadays, a recently strengthening dollar provides currency headwinds for MCD's global business. However, I do not see this as being a major problem because demand and sales should easily overshadow any currency implications.

Why might you ask? The answer is simple: consumers worldwide trading down to "cheap" alternatives. McDonald's is the king of cheap. After all, it is a fast-food chain, with a $1 menu, to boot. When consumers are in a pinch, they look to save money any way they can. McDonald's allows them to do just that. As I wrote about here, the U.S. economy is accelerating to the downside. Goldman Sachs (GS) thinks that half the globe is in a recession, and you have the former Fed chairman Paul Volcker claiming that growth in the U.S economy will be the slowest of any decade since the Great Depression, as I noted here. Tough times are ahead - to say the least.

The U.S. consumer is in for a wild ride. So, if you're going to play any consumer stock in such a tough environment, make sure it is a company that deals with necessities. McDonald's provides food, and cheap food at that. If you don't buy the rationale, just look at McDonald's most recent quarter.

McDonald's delivered yet another dominant quarter last Tuesday. August sales in the U.S. increased 4.5% compared to an analyst expected 3.5% gain. Sales in the Asian Pacific region gained 10% and an 11.6% gain in Europe compared to analyst expectations of only 6% in Europe. On average, analysts pegged McDonald's at a global increase of 4.7%. McDonald's came in with an 8.5% gain globally.

It was a dominant quarter. The company is winning over cash-strapped consumers in both the U.S and Europe, and its market position in Asia continues to be very profitable. MCD is also seeing operating margins of 25.78% and a return on equity of 29.71%. These are both solid numbers, which reflect the strong underlying fundamentals.

People were concerned that economic weakness in Europe would hurt sales. However, I would like to argue just the opposite. A weak economic environment means more people trade down to cheaper alternatives. European consumer confidence is at one of the lowest levels in five years. Its economy is contracting as its consumers face the exact same problems ours do: rising food and fuel prices. In the U.S., the cost of living rose 5.6% for the year (ended in July). The U.S. Labor Department reports that it is the largest jump in 17 years. Therefore, as the cost of living goes up, consumers look to trade down - it's that simple.

If you're worried about consumers "shutting down" altogether, then look to go long MCD and hedge your position by buying some puts or by shorting rival discretionary casual dining restaurants such as BJ’s Restaurant (BJRI) or Darden Restaurants Inc. (DRI). Those casual dining chains are suffering from rising input costs and slower dining traffic. At any rate, I think MCD is a solid choice going forward.

Let's see how it sets up on the technicals. Pulling up a three-year chart on MCD, we see that it is in a nice long-term uptrend. Every major dip in the name has been a buying opportunity, as you can see below.

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Then, zooming in on a closer six-month time frame, we can see how MCD has been trading recently.

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You'll notice it put in a most recent high at around $65/66, and then sold off. That level represents some near-term resistance in the name and you could see some sellers come in as MCD began to trade back up near those levels as it is doing now. What you'll also notice is that during the months of May, June, and July, MCD was bumping up against severe overhead resistance at around $60/61. The lower of the two horizontal red lines that I've drawn in shows this. You can see that it kept bumping up against that resistance level before finally enough buyers came in August to push it through to new highs.

After those recent highs, you will see that MCD came back down to that $60/61 level that was previously resistance. In addition, that level now acts as a support level to the stock as it bounced off those levels, trending back higher. Therefore, in terms of selecting opportune entry, exit, and stop loss points, the chart gives us a pretty clear picture. But, how you play it is determined by whether or not you are an investor, or a trader. However, as outlined above, I think McDonald's is poised to benefit in the coming months.

Disclosure: marketfolly.com is long MCD.

Comments

[steveballmer:]

Microsoft is the McDonalds of software! Over 1 Billion served!

2008 Sep 12 12:39 PM

[Urbane Gori...:]

I don't think McD would like to be compared to MSFT.... McD's stock is climbing ... MSFT isn't. jegan

2008 Sep 12 08:40 PM

[Bisso_zwei:]

Yeah if you have a lot of money you want to put somewhere safe MCD and KO is the place to go.. people need to eat and drink no matter whats going on with the economy.

But a young dude like me with little amounts of cash has to get into small growth companies instead. Mcd will grow maximum 5-10% yoy

2008 Sep 13 09:24 AM

[mcdinvester:]

Right on, you could'nt have said it better.McDonald's is the place to be at this time and for the near future. its a buy for sure.

2008 Sep 14 01:43 AM

[WEBISKING:]

low cost provider during consumer slowdown is great trend ask wmt dltr etc

2008 Sep 14 11:58 AM

[Francorp:]

McDonalds is still a great play. My company has done a great deal of work with McDonalds in the past and we have been impressed with McDonalds no matter what the economy and what the circumstances are.

2008 Sep 24 01:46 PM