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Big Mac Anyone?

|Includes: GS, McDonald's Corporation (MCD)

Intro

MCD is one of the most admired company in the world, proven track record time and time again. The last couple of years it has been revamping it's stores all over the world and slowly converting some stores to McCafe serving delicious hot latte and icy cold frappe. I think their strategy has worked to perfection. Not only it attracts the normal younger audience/ student to their big Mac offerings, now it has starting to attract different demographics with their coffee selections. I think it's the best of breed in terms of restaurant.

A Picture is worth a thousand words

MCD

At the moment it's testing it's 200 days moving average and as someone famous always says " it's moving from the lower left to the upper right" which is a good direction if you are long it. It hit 52 week high of $80.94 a few days after it went ex-dividend back in late November 2010

Latest development

On 15th of Dec 2010, one of it's top executive reiterates it's ambition in opening 1000 extra restaurants by 2013 and 200 of them would be open by this year 2011. It's top competitor YUM( who owns KFC, Pizza hut and Taco Bell) has about 3700 outlets in China at the moment. China is by far it's biggest growth engine. As of 2009 McDonald operates 32,478 restaurants across 117 countries. In another words, by 2013 China alone contributes to 3% growth of the number of stores globally. In 2009, all else being equal each stores contributes to USD $700,320 of revenue. Therefore in 2011 potentially the revenue will go up by USD $140 million, even if the same store growth is nil. Now in terms of it's marketing, I like their idea in introducing new menu every now and then to each different geographic market. Now, from what I can see these new burger(Angus Burger in Australia or Samurai burger in Singapore) are priced at a premium compared to Big Mac. This is one of the reason where they WILL grow their same store sale. Another initiative which I think would improve their same store sale is re-imaging their existing restaurants, for example in 2009 the company has re-imaged 900 restaurants which include 290 McCafe's. McDonald also operates a very efficient machine, it's net margin 20.65% is one of the highest if not the highest among the fast food restaurants. For comparison YUM net margin is 10.04 %. So far so good. Now the bad news, is input cost is going up. We all have heard about food inflation, the commodity from crude oil, palm oil, wheat, corn, etc have gone up a lot and looks set to continue. Therefore I would imagine their net margin would be impacted. But I rather be in MCD then in YUM.

Valuation/Fundamental

P/E in the last 9 years is 19.3, current P/E is 16.4

Net Profit margin is at 20.7% the highest in the last 9 years

Earning in 2009 is $4.17/share

Net income growth rate in the last 5 years is 14.85%

By projecting it's earning and then multiplying it by its average P/E and then discounting it back, I got the valuation of around $78 and my price target for 2011 is $91/share. Goldman Sachs put MCD on neutral with price target of $88/share on 16th of Dec 2010.

How do we play it?

I sold $75/70 Feb 2011 Put spread for a credit of $0.79 as I am expecting MCD to trade sideways for a while. It's not exactly a fast money but for 19.2% return for about 60 days or so I'll take it. And if I indeed got exercised, I am more than happy to buy it at $74.21 net (Exercise price - premium that I received). Don't forget if exercised there is a further dividend rate of 2.44%

Let's go out and play !!



Disclosure: I am long MCD.

Additional disclosure: Long MCD via Option