Picture the time it takes to eat a quick lunch when you are in a rush or late for an important business meeting. Probably not very long, I would imagine, and the quality of the experience eating was nothing memorable most likely. Now picture the time it takes to eat a nice dinner with a friend or family member, on your day off, at a nice restaurant of your choice. It is safe to say that it is probably of a longer duration than the quick lunch in a rush, and leaves you with a satisfying experience. The concept of devoting more time to something great - the nice dinner at a good restaurant - can be applied to investing in McDonald's (MCD), which may be a slow mover and grower, but with time and patience can provide excellent returns for the long-term investor, giving the word "healthy" double-duty to describe food offerings and the stock as an investment.
McDonald's on the Value Menu
McDonald's, an American household restaurant name that can be found in 119 countries worldwide, has consistently proven its worth throughout history. What started as a small barbecue food stand has turned into a solid eating establishment that will only grow even further with time. Unfortunately, however, McDonald's has not been immune to global economic weakness and rising food prices.
On October 19th, 2012, McDonald's posted the worst quarterly sales growth in nine years and disappointed the Street with its quarterly earnings report, which saw diluted earnings per share of $1.43, down two cents from the same quarter in 2011. The CEO, Don Thompson, attributed the results to increased competition, such as Chipotle (CMG) and Taco Bell (YUM), as well as a stronger dollar, which decreases the amount returned back to the homeland for internationally-exposed American companies.
The company recently traded at $87.20, down over 11% from its 52-week high of $102.22, given the disappointing earnings call. The fact of the matter is that the price per share could be considered oversold at this level, considering:
- A P/E of only 16.45
- It was last at this level after the second quarter of 2011, when income was less at only $1.35 per share
- Comparable sales increased in every region worldwide, with global comparable sales increasing 1.9%
The stock should be considered affordable and possibly oversold at this level, and is a promising buy given investors should not be worried about competition or global weakness for several reasons.
Defeating the Competition
The lack of earnings growth was partially attributed to the effects of competition stealing customers and sales. I feel confident, however, this is merely temporary in nature, and McDonald's should regain market share once temporary fads and customer curiosity in competition fades. Let's consider what McDonald's is up against from other chains:
- Healthy Offerings: Competitors have recently been upgrading menus in an effort to offer healthier options and newer tastes. Taco Bell, for example, is now offering a Cantina Burrito as a healthier choice to a menu of otherwise average fast-food quality nutrition; Wendy's (WEN) is beginning to embrace healthier eating, as well. However, McDonald's is ahead of the curve - it has been offering healthier alternatives for several years now, including grilled chicken sandwiches, salads, apple fries instead of French fries, yogurts, oatmeal, and so on.
- Breakfast: Competitors are also trying to gain a share of the breakfast scene, with Taco Bell entering the breakfast market by offering a tortilla stuffed with egg and hash brown and Subway having started offering breakfast in the late 2000's. At other restaurants, breakfast is still completely non-existent, such as at Wendy's, Chipotle, KFC, A&W, and other competitors. McDonald's, however, has been serving breakfast since 1971, when the Egg McMuffin was introduced to the menu, and has increased its offerings greatly to provide a complete breakfast menu during the morning hours.
- Coffee: The McCafe line of coffee drinks, which Mr. Thompson first created in 2007, has been well-received, and restaurant locations now typically include Wi-Fi and renovated seating at some locations. McDonald's also announced on October 25th, 2012 they will start selling bagged coffee in Canada and possibly other countries depending on demand-a step ahead toward competing with other bagged coffee suppliers, such as Dunkin' Brands (DNKN) and Starbucks (SBUX).
- Adaptability: The CEO has stated in the recent earnings conference call that "the McDonald's system remains focused on building the business for the long-term by meeting the evolving needs of our customers." This has been proven not only by the upgrades and new products added to the menu to adapt to changing customer tastes, but also by the long-standing fact that McDonald's also adapts to regional taste preferences and local palates by offering customized menus.
- Franchise Growth: McDonald's plans to open thirty more Canadian stores by the end of 2012, and hopes to open 250 more stores in India by 2015. McDonald's currently has 270 stores in India, more than the 160 KFC locations competing for the Western fast-food appeal in the country. More locations equal more sales, a step above competition, and of course, more franchising-related income for the chain, which ultimately increases the bottom line for the chain.
Essentially, McDonald's is still the leader in adapting and overcoming changes to customer preferences in the fast-food industry, and any lost revenue due to competition is most likely temporary in nature - perhaps attributable to short-lived fads or customer curiosity in new offerings from rivals.
Dividend Investing to Ride Out Weakness
Remember that part of the reason McDonald's failed to grow earnings was due to a general global economic weakness. Marketed as an affordable place to eat, we have seen during the late-2000s Great Recession that McDonald's can still do reasonably well when people need to cut back on their food budget, as shown by the stock price doubling during this time period before the recent pullback.
Long-term investors that are able to ride out weakness and temporary curveballs from competitors are rewarded with a generous and growing dividend, currently $0.77 quarterly, or a 3.5% annual yield. McDonald's has increased the dividend annually every year since 1976 without fail, and it is reasonable to expect this trend to continue indefinitely.
Given this generosity and investor-conscious track record, this will yield enormous dividend payments in a few years' time. Consider the fact that if you purchased shares of McDonald's as little as three years ago to this date, in October 2009 when the PPS was around $58, you would now be receiving about 6.5% in annual dividends, in addition to 47% capital gains. Not bad for only two years of waiting!
For all of these reasons, I strongly believe McDonald's will overcome temporary competitive pressures and global weakness, and will provide an excellent dividend growth opportunity and solid capital gains for the future-minded long-term investor.