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Omar Venerio
Omar Venerio
Articles (1746) 

McDonald's Reports Strong 3rd Quarter

The fast food chain is a favorable investment compared to competitors

McDonald's Corp. (NYSE:MCD) is a $103.7 billion market cap company and the largest fast-food restaurant chain in the world, with about 35,000 restaurants in 119 countries.

Third quarter results

The past month, the company reported stronger-than-expected third quarter results. Revenue declined by 5.33% to $6.615 billion from $6.987 billion, but EPS increased to $1.40, up from $1.09 in the year-ago quarter. We must highlight that some revenue lost was caused by currency translation losses, and this phenomenon could increase in the future.

Looking ahead, we expect revenue growth. Performance is improving in the U.S. and China, but some challenges exist in Europe and Asia, areas in which the firm has few restaurants.

Outlook

We believe that competition will be hard in the future, and it will be important to maintain prices while making decisions on differentiation. We can divide competitors into stable ones, like Yum Brands (NYSE:YUM), and others more volatile like Panera (NASDAQ:PNRA) and Chipotle (NYSE:CMG). Ever-changing consumer preferences are always adding risk to the firm´s future. Moreover, its size allows it to invest more in advertisement campaigns than its peers.

Further, there have been some organizational changes and initiatives, which include an accelerated pace of global franchising. We should remember that McDonald´s operated and franchised more than 36,000 restaurants around the world at the end of last year. Also, the 24-hour breakfast initiative was fundamental for the quarter´s results.

Operating margin

When looking at performance indicators, the operating margin has expanded to more than 30%.

Quarter Ended

Jun-13

Sep-13

Dec13

Mar-14

Jun-14

Sep-14

Dec14

Mar-15

Jun-15

Sep-15

Operating Margin (%)

31.02

33.00

31.02

28.89

30.48

29.66

26.65

23.25

28.46

30.69

Despite this, there exist some risks because the restaurant industry is very exposed to cyclical headwinds, as well as unemployment rates and commodity prices.

Dividends and share repurchases

The company returns good cash to shareholders via dividends and buybacks. Year to date, it has returned about $8 billion to $9 billion through dividends and share repurchases. The stock's yield is 3.03%, close to a five-year high and is ranked higher than 74% of the 308 Companies in the Global Restaurants industry.

Recent news

The company has recently announced the return of french fries to Venezuela. It took ten months to return to the menu after being removed in January.

The company has a good current ROE of 55.5% that is higher than the industry median and the one exhibited by Wendy's (NASDAQ:WEN) and Darden Restaurants (NYSE:DRI). In general, analysts consider ROE ratios in the 15% to 20% range as representing attractive levels for investment.

It is very important to understand this metric before investing, and it is important to look at the trend in ROE over time.

Relative valuation

The stock sells at a trailing P/E of 24.39x, trading at a discount compared to an average of 25.5x for the industry. To use another metric, its price-to-book ratio of 12.80x is close to the 10-year high of 12.85x and the price-to-sales ratio of 4.21x is also close to 10-year high of 4.23x. It is fair to mention that the long term traditional P/E is around 17x, so it is overvalued compared to its past history.

As we can see in the next chart, the stock price has an upward trend in the five-year period. If you had invested $10,000 five years ago, today you could have $16,959, which represents an 11.2% compound annual growth rate.

Final comment

Although competition has increased steadily, we believe McDonald's fundamentals are improving.

Clearly, this was not the sentiment of gurus in the third quarter. Brian Rogers (Trades, Portfolio) sold out the stock, while Ken Fisher (Trades, Portfolio) reduced his position by 27.63%. Other reductions came from Manning & Napier Advisors (-6.30%), RS Investment Management (Trades, Portfolio) (-0.18%) and First Eagle Investment (Trades, Portfolio) (-1.28%).

Disclosure: Omar Venerio holds no position in any stocks mentioned.

About the author:

Omar Venerio
Omar Venerio is a capital markets, derivatives, corporate finance and financial management professor and Area Head of Finance. He is passionate about the stock market and providing independent fundamental research and hedge fund and insider trading-focused investigation.

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