Wednesday, August 24, 2011

Why McDonald's Is More Than Empty Calories For Your Portfolio

McDonald's (NYSE: MCD) has been a powerhouse under its current CEO and it looks like that momentum could continue after he retires. But is it too late to tuck into McDonald's shares?

Fortune wrote an interesting article about its current CEO Jim Skinner who has helped to boost McDonald's sales per store by 50% since he took over in 2004. At its 33,000 stores in 118 countries, average sales have increased from $1.6 million (2004) to $2.4 million (2010). And under Skinner, McDonald's stock has returned over 250% vs. 16% for the S&P 500.

Skinner has done this through excellent management. This is particularly important since McDonald's are 80% owned by franchisees who are not under McDonald's direct control. Thanks to Skinner's experience running McDonald's stores, he will only allow new products into the system if they do no involve a big interruption in the way the stores currently operate while offering profit potential in excess of their costs and global sales potential.

McDonald's applies a similarly rigorous process for developing management. After all, prior to Skinner, its two previous CEOs died suddenly -- thus putting a premium on management depth. Skinner has created an effective leadership development program and he makes sure that each manager has a number two who is ready to take over at a moment's notice and someone else on deck who can take over from the number two if that person gets tapped for a bigger job.

And its second quarter earnings report was excellent. McDonald's reported a 15% increase in profits and beat EPS expectations by seven cents a share -- posting second quarter EPS of $1.35 as more consumers dined out and McCafe beverages boosted sales, according to Bloomberg. Sales at its stores open more than 13 months rose 5.6% -- beating analysts' expectations of 4.1% growth.

Does all this mean that McDonald's should be in your portfolio? Here are three reasons to consider buying the stock:
  • Attractive dividend. McDonald's dividend yield is a relatively high 2.73%.
  • Good quarterly earnings. McDonald's has been able to surpass analysts’ expectations in four of its last five earnings reports.
  • McDonald's is out-earning its cost of capital. McDonald's is earning more than its cost of capital – and it’s progressing. How so? It produced no EVA Momentum, which measures the change in “economic value added” (essentially, after-tax operating profit after deducting capital costs) divided by sales. In the first six months of 2011, McDonald's EVA momentum was 3%, based on first six months' annualized 2010 revenue of $23.1 billion, and EVA that rose from $2.3 billion in the first six months' annualized 2010 to $3 billion in in the first six months' annualized 2011, using a 9% weighted average cost of capital.
Here are two reasons to hesitate:
  • Expensive stock. McDonald's price to earnings to growth of 1.81 (where a PEG of 1.0 is considered fairly priced) means it is expensive. It currently has a P/E of 18.1 and is expected to grow earnings 10% to $5.74 in fiscal 2013.
  • Increasing sales and profits -- but more debt-laden balance sheet. McDonald's has been increasing sales and profits. Its $24.1 billion in revenues have risen at an average rate of 3.6% over the last five years while its net income of $4.95 billion has increased at a 14.6% annual rate -- yielding a tremendous 21% net profit margin. Its debt has risen faster than its cash. Its debt has climbed at an 8.2% annual rate from $8.4 billion (2006) to $11.5) while its cash inched up at a 3.4% annual rate from $2.1 billion to $2.4 billion during the period.
McDonald's is a well-managed company with solid future prospects. At its current price, it looks like investors have already discovered this. But it should definitely be on your shopping list when market plunge as they did earlier in the month.


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