McDonalds (MCD) – Are You My Favorite?

McDonalds (MCD) – Are You My Favorite?

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Once again eyes are on McDonalds (MCD) for the most popular reason nowadays, The Olympics! McDonald’s has been a proud sponsor of the Olympic Movement for more than 35 years. More importantly, Ricky Berens and Michael Phelps gorged at McDonalds after their gold medal winning on Tues night. Two Quarter Pounders with cheese, one Big Mac, one six-piece nuggets, two medium french fries and a medium McFlurry which accounts for 3,300 calories. What better time to think of a possible investment theme around McDonalds?

For starters, lets recap recent happenings around the stock:

Recent earnings announcement: MCD reported 2Q12 EPS of $1.32 versus consensus of $1.38. For comps by region, US + 2.9% vs. consensus of +2.5%, Europe +5.1% vs. consensus of +0.4%, and APMEA came in as +3.5% vs. consensus of +2.5%. FX had a $0.07 impact on EPS vs, guidance of $0.07-0.09, and is expected to impact 3Q EPS $0.08-0.10. The company returned $1.6b to shareholders in the form of dividends and share repurchase. So in summary, the gloomy quarter was the result of austerity measures in Europe and the sovereign debt crisis that kept people cooking at home instead of dining outside, weakening same store sales and negative impact of currency and the commodity prices. All this resulting in a 3% drop in the stock post earnings.

Commodity price pressure seems to be easing:

Although MCD saw 4% commodity inflation in Europe, they brought down guidance to 2.5-3.5% for FY2012. In addition, management has now locked in the demand for commodities to hedge any risk pertaining to a spike in prices due to a recent drought in the U.S. This should ease pressure on earnings going forward.

Europe, austerity measures and competition:

Europe comps were up 3.8% in 2Q12 vs. 5.9% last year. Europe restaurant margins were 19.3%, down 30bps yr/yr due to increasing costs in labor and commodities.

Challenging consumer spending requirement:

It’s a challenging global consumer spending environment and lagging sales in April and May show that consumers now have several alternatives to fulfill their craving for QSR’s (Quick Service Restaurants). We did a quick survey and our sample of QSR clients thought that better value was offered at In&Out, Burger King (BKW) and Five Guys.  It’s pretty clear to us that McDonalds has heavy competition from consumers with access to various alternatives.

That being said, does McDonalds maybe just have an advantage due to the location of the stores? A 50,000 sq ft corner location with 2 signs visible from 2 major streets might benefit work to their advantage.

According to our experts at NPD group, we are a culture of constantly on-the-go and hungry people. In 2011, Americans made 12.4 billion visits to fast-food drive-thrus, a 2% rise from 2010. Hamburger joints, unsurprisingly were our favorite for drive-thru orders: 57% of all visits to McDonald’s (MCD), Burger King, Wendy’s (WEN), and other fast-food hamburger restaurants were of the drive-thru variety.

So is MCD just a leader because they have great advertising, offer a lovable and consistent menu along with the $1 value menu, and now offer healthier foods?

Business Section:

McDonalds has had a very good run in the last decade since they announced “Plan To Win” and started focusing on quality and value instead of only size.  MCD is currently trading at 16.2x versus its 3yr range of 13-18x and average of 15.6x since 2005.  Its peer group consisting of Starbucks (SBUX) and Yum! Brands (YUM) are trading at 25x and 20x respectively.  Also, a 3% yield on the stock might help support the shares to trade in a range. There are no near-term catalysts to be a mover and shaker for the stock so perhaps MCD is just a safe haven for those who want to invest in the Quick Service Restaurant Space (QSR).

Risks:

We think the risks to the McDonalds story revolve around 1) Drop in consumer spending both in the U.S. and in Europe which would continue to hurt sales going forward, 2) Foreign currency pressure which would impact sales, margins, and earnings, 3) An increasing cost in commodities and labor, 4) A growing competitive landscape

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Below is a chart comparing how the company has performed against its competitors

 

Written by Sabina Bhatia

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