Why I Still Think McDonald’s Is a ‘Buy’
In June of last year, I penned an optimistic commentary suggesting the king of the fast food chains, McDonald’s Corp. (NYSE: MCD), was a solid buy. This came despite the 11% pullback leading up to that call, the fact that the company had warned upcoming earnings would tumble about 6%, and that Goldman Sachs had changed its opinion of McDonald’s from “buy” to merely “neutral.”#-ad_banner-#
To be fair, the stock is now trading about where it was then, so the “buy” call hasn’t bore fruit yet. But a handful of new factors has materialized that continue to convince me this iconic stock is being underestimated.
That was then
The seven months since that detailed look at McDonald’s haven’t been easy. Shares have moved as high as $94.09 and as low as $83.31 before finding the $92 level again. The prods for all that volatility were mostly earnings-based, some good and some bad.
As expected, when McDonald’s posted its second-quarter earnings, they were lower by 2.2%. Even more alarming was per-share profits of $1.32 — rolling in 4.3% lower than average estimates of $1.38. Weak demand in Europe and rising food costs were deemed the primary culprits. Remember, the drought of 2012 was well underway by that time, driving the price of meat, corn and wheat much higher.
Then in the third quarter, the organization also reported a 3.5% dip in earnings on a modest slide in revenue. It was quite un-McDonald’s-like, even if currency fluctuation — which is completely out of the company’s hand — was the root cause of the contracted numbers. Also with the third-quarter earnings report, McDonald’s reiterated it was dealing with improving competition and Europe’s tightened consumer purse-strings.
The company missed two earnings estimates in a row after three straight years of beating or meeting those numbers. Even worse, the two consecutive declines in year-over-year quarterly income had shareholders understandably worried.
This is now
The good news for McDonald’s today is the nagging problems it was facing in the middle of 2012 have been mostly abated.
For starters, drought-raised corn prices are back to more palatable levels. They’re still high at levels around $7.24 per bushel, but well off of August’s peak price of about $8.50. And corn prices are still in a broad downtrend.
Europe’s self-imposed austerity mindset is also fading. The International Monetary Fund‘s Chief Christine Lagarde has recently noted that it sees the eurozone growing rather than contracting in 2013. Europe’s Economic Sentiment Indicator ticked higher for a second month in a row in December, after falling each month since January of last year. The euro hit an 11-month high the second week of January, underscoring how traders are rebuilding their faith in the European Union’s economy.
As for improving competition from the likes of Burger King (NYSE: BKW) and Wendy’s (NYSE: WEN), McDonald’s will do what it always does: Hit them head-on with promotions and new menu items. The restaurant’s new chicken wings, first tested in Atlanta and now Chicago, have been well received so far.
The transition from troubled times to better days for McDonald’s could already be underway. The company posted 2012’s fourth-quarter earnings on Jan. 23, with a net profit fo $1.38 per share, up from $1.33 earned in the same quarter of the previous year. Analysts were looking for earnings per share (EPS) of $1.33.
With the upside surprise in earnings, McDonald’s looks well positioned to begin a recovery in 2013. While investors are still cautious when it comes to the fast food company, they may want to also respect that fact that it’s still McDonald’s: the company’s worst-case scenario is still better than many companies’ best-case-scenarios.
Risks to Consider: Although McDonald’s is in the same boat as Wendy’s and Burger King when it comes to commodity costs, it still has an oversized reliance on Europe, where it generates 40% of its revenue. We’ve already seen that if Europe falters, then McDonald’s does too.
Action to Take–> McDonald’s has a place in nearly every value-oriented and income-oriented portfolio, even if the last year or so has been a weak time for the stock. Despite worries that the company would hit some major speed bumps in 2012, sales and income have still been growing. While it may be unfair to expect the stock to hit an annual growth rate of 30% or more this year, it would be fair to expect a climb of 10% to 20% during the course of 2013. That’s the pace at which it’s been moving since 2003. Throw in the consistently-growing dividend and a yield of almost 3.5%, and McDonald’s is still an ideal all-around holding. It just needs time to make good on its potential.