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McDonald’s: The Hottest Stock in Fast Food
Posted by: InvestmentUnderground (IP Logged)
Date: March 27, 2012 09:49AM

You can say what you want about how fast food tastes, but this much is true: Investors can't get enough of these profitable stocks. For decades, McDonald's (MCD) has been extremely successful, rewarding its investors with big dividends and gains. Fierce competitors in the fast food industry include Domino's Pizza (DPZ), Wendy's (WEN) and Yum! Brands (YUM). Yet, I believe McDonald's stock is still the tastiest item on the investment menu. I will discuss this below.

McDonald's is a global entity, an icon in both the U.S. and throughout the world. The company has created a familiarity that makes it both a respected restaurant chain and an incredible investment. For more than 25 years, McDonald's has been an S&P Dividend Aristocrat, providing investors with excellent dividends and gains at the same time.

Offering nearly 38% return on equity, the company had a great year in 2011. Beating the market, McDonald's stock price has surged 30% over the last 12 months, and the company enjoyed quarterly increases in both revenue (up 9.8%) and earnings (climbing 10.8%). Sitting on nearly $4 billion in free cash flow, the company is well positioned to see further growth (its one-year targets represents a 10% increase in share price), even though it has a price to book ratio of over 7.

McDonald's has experienced a temporary decline as the ongoing European crisis tempered sales, causing the company to miss estimatesfor the first quarter. While such news scares many investors, those holding McDonald's stock should still be thinking about buying, not selling, on the pullback. The company's global operations will allow it to perform well this quarter. The currency exchange rate and stronger U.S. dollar will help here.

YUM! Brands (YUM) is another solid performer in the restaurant industry. Combining KFC, Pizza Hut and Taco Bell into one powerful business entity, this $31 billion company has done a great job of leveraging its popular brand images to increase sales. Pizza Hut is using a special promotion to generate interest during the NCAA men's college basketball tournament, while Taco Bell combines tastes with snack chip Doritos to introduce a new taco.

Marketing moves like these andexpansion into distant places like China are among the reasons that YUM! enjoyed 15.4% quarterly revenue growth and an earnings increase of nearly 30%. The company pays a nice annual dividend of $1.14 for a yield of 1.7%.

YUM! Brands is expanding in other countries as well. The company recently announced that Indonesia is the largest market for its international brand, and Vietnam is its fastest growing emerging market. This expansion overseas is helping the company also to overcome intense domestic competition, making it possible for analysts to predict double-digit earnings per share growth for YUM! over the next couple years.

YUM!, like McDonald's, has its problems. The company has a hefty price to earnings ratio of 24.5 and its price to book is approaching 17. In addition, it has a debt to equity ratio of 177, suggesting that the cost of making money is weighing heavily on the company. Although YUM! is a growing company, its money problems could become an issue in the future, possibly forcing dividend cuts or slowdown of company expansion.

Domino's Pizza (DPZ) is another of the fast food restaurants that has done well recently. Reinventing its image after dropping to $3 per share in 2008, Domino's has recovered nicely, raising its share price thirteen-fold and being recognized as Pizza Today magazine's "Chain of the Year" for the second consecutive time. The recognition comes as strong domestic and overseas sales pushed the company to a 123% jump in share price over the past 12 months and quarterly increases in both revenue at 4.5% and earnings at 28%.

Domino's performance over the past few years has been impressive, but there is concern among investors that the company will have trouble sustaining that growth in the days ahead. After a share price increase in late February pushed it more than 30% above its 200-day moving average, Domino's stock is expected to remain flat for the next 12 months. The price to earnings ratio is a hefty 23.2 and since the company does not pay a dividend, the predicted performance means little or no gains in 2012 for shareholders.

With YUM! experiencing debt problems and growth at Domino's going flat, McDonald's continues to be a solid investment option. The company's overseas expansion has helped to increase sales, and theefforts to change the signature appearance of its restaurants have created a more inviting dining experience. I see these moves as a corporate effort to update its brand image, improving on what is already one of the best in the world.

McDonald's offers growth and stability to its investors, and its consistent dividends have kept the company among the elite business opportunities for decades. Both YUM! Brands Inc. and Domino's Pizza Inc. have done well recently, but I am not confident in their profitability at the present time. The potential debt issues at YUM! raise a red flag of concern, while the projected lack of growth and nonexistent dividend at Domino's eliminate the incentive to invest in the company. McDonald's, on the other hand, has expanded its market penetration overseas and sustained its share price growth, while continuing to offer impressive dividends.

On Thursday, McDonald's dropped 3.2% on news of weak same store sales in February and first quarter warnings — Europe's financial issues, along with increasing labor and commodity costs. Sales increased 4%, versus an expected 6.1%. This disappointing performance in the European market could continue for McDonald's, as the European Central Bank is eying inflation in order to cover energy costs and other set prices.
Also, the harsh winter in Europe certainly dealt a blow to the company's results. But investors should stay focused on the bigger picture here. McDonald's is in an excellent position to weather any economic impacts, due to its global reach, strong U.S. sales and modernization of its restaurants, which is expected to be a positive driver for the long term.

Factoring in the weakness I have noted at YUM! and Domino's, I have a neutral outlook on both. I consider McDonald's to be a strong buy despite Thursday's news; the company continues to exceed expectations in most categories, making its stock a great long-term holding.


Stocks Discussed: MCD, DPZ, YUM, WEN,
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