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McDonald's: Still Strong, Despite Headwinds

March 14, 2012 | About:
McDonald's (MCD) is by far the world's largest fast food restaurant chain. The company operates in over 110 countries and has over 32,000 restaurants of one form or another. McDonald's operates through its company owned restaurants, where it trains management personal and tests new products, but company owned restaurants only make up 30% of McDonald's eateries. The other 70% of the establishments are franchise owned and this business model represents a significant cost savings to the company in my opinion.

McDonald's has been expanding globally for decades and has done so through its franchising operations only. This has provided the company with a significant source of revenue growth over the years with relatively little in the way of overhead. In the United States McDonald's has been driving growth through renovating its facilities, expanding menu options and extending store hours.

There has been a sell-off recently in the stock and hopefully you were not a part of it. McDonald's is a solid long-term investment with terrific growth potential. It is a stock that will carry you through thick and thin.

Throughout the recent recession McDonald's has continued to perform well despite the reduction in discretionary spending. In my opinion, this has been the direct result of the renovation of its restaurants, drawing in new customers from more expensive establishments trying to cut costs. The expanding of its menu options have also gone a long way in retaining regular customers during the downturn — specifically the expansion of its value meals.

These drivers of domestic growth have also allowed the company to steal customers away from competitor Starbucks (SBUX) through the expansion of its specialty coffee menu. This is a niche that could grow still further for McDonald's as people who have grown accustomed to these specialty coffees grow weary of the comparatively high price of Starbucks. Furthermore, in a busy workday (especially in the morning) most people just don't have the time to stop and will be taking advantage of McDonald's drive thru for their espresso fix.

McDonald's international operations are also driving profit growth, especially within the growing middle class in emerging markets such as the BRICK nations of Brazil, Russia, India and China where the company has a strong and ever growing presence. According to a recent economic study (McKinsey & Co.), emerging market consumer spending is estimated to expand from its current level of about $7 trillion to more than $20 trillion by 2022. Recent events in these nations and in Europe will in no way affect this long-term growth trend, so a long-term position in a company like McDonald's bears very little risk with some serious upside potential. This growth potential is far greater on relative terms to the company's closest domestic competitor Burger King (BKC), for example, that has yet to make a significant global footprint.

McDonald's is already well-established in Europe where its major source of revenue and growth presently come from the individual countries of France, Germany and the UK. The company is also well established in Canada, South Korea, Australia, Asia, the Pacific Islands, India, the Middle East, Russia, Eastern Europe and Africa. It has adapted its menus to fit local cultures in these areas such as modifications of the Filet-O-Fish in China, the Teriyaki Mac in Japan and lamb instead of beef in India.

McDonald's economies of scale benefit the company in various ways in its international endeavors including: the fact that its uniform menu offerings can be mass produced, lowering production costs; the company's bargaining power with its suppliers lowers its input costs and boosts margins; the company's large advertising budget gives McDonald's a significant competitive advantage over its competitors. Presently 60% of McDonald's sales occur outside of the U.S. In my opinion, by tapping into this growing global middle class the company's international operations will continue to post strong same store and new store sales growth overall into the next decade.

It is not very smart to sell your stock on one data point such as one bad quarter, much less one bad month, but that is exactly what happened to McDonald's stock after a recent monthly report that didn't quite meet analysts' estimations. The survey was compiled by Consensus Metrix. Analysts apparently underestimated the effect Europe's harsh winter and economic confusion would have on sales, in addition to the earthquake and tsunami in Japan still producing aftershocks. This kind of activity usually rubs me the wrong way and when I see it I generally switch off my computer and turn on Animal Planet. At least this way I can watch herd mentality without any money being involved. Any meaningful statistical data requires thousands of data points to draw any logical conclusions. However, when the dust settles and the gazelle have gone back to grazing, the long-term investor is usually left with a terrific buying opportunity.

Looking deeper into the numbers the report was actually quite good in many respects and the short falls were mostly due to rare events and natural disasters that are imposable to predict. The effects of these rare events are also equally as difficult to quantify and the time periods metrics should be taken with a grain of salt. Analysts surveyed by Thomson Reuters were looking for a worldwide sales gain of 7.7 percent which was actually closer to the mark but went widely unnoticed. However, the perma-bears and chicken littlies of the world every once in a while get the attention they crave — and profit at your expense (that is, if you took part in the sell-off).

If you own the stock I would highly recommend that you hold on to it — for this too shall pass. If you are thinking of picking up the stock or increasing your position I would not buy the whole stake at this point. The company's first quarter report may disappoint and drive the stock down further at which point short sellers will buy back in and value investors will start jumping on the band wagon, in my opinion. McDonald's next earnings report is slated for April 20.

About the author:

Dividend King
I am primarily an investor interested in creating passive income streams through dividends. I focus on finding and analyzing dividend paying stocks, MLPs and REITs that are a good fit for income investors.

I practice Judaism and my faith is very important to me. I visit family in Israel once a year, but I am educated and work in the United States where I hold an MBA and a bachelor’s in English. I am a patient man, enjoy wine but am not a connoisseur, and I listen more than I speak.

Visit Dividend King's Website


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