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NewAlchemist (44.06)

McDonalds pitch

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May 07, 2013 – Comments (0) | RELATED TICKERS: MCD , BKW , KO

A few years ago I went on vacation to Hawaii.  It was about 12 hours of traveling and a 6 hour time difference.  Needless to say I was exhausted when I got there.  The initial excitement pushed me to check my immediate surroundings in paradise before falling asleep around 4 or 5 PM. 

I woke up bright and early the next morning before everyone else and decided to take a walk and maybe find something to eat.  There weren’t that many cheap eats open for breakfast but I did see a McDonalds and a Burger King in the middle of the strip.  I ventured into the McDonalds and it was literally packed, my eyes as an investor lit up.  It was a large restaurant, with a line, and almost every one of the 30 or so seats in the store were taken.  It was packed when I got there and when I left.  Some diners had to carry their food out due to the scarcity of seating.  It was like that every day for a week, I couldn’t believe how packed a McDonalds could be at 7 AM.  The Burger King a few blocks away had a small seating area and usually had 0 to 5 diners.  What also impressed me was that they served the local pineapple too.  A nice touch and an example of how McDonalds changes their menu to meet local tastes.

McDonalds is my least favorite fast food to eat, but it is my favorite restaurant investment.  A lot of restaurant stocks are only open for lunch and dinner.  Some fast food places like Burger King or Chic Fillet are open for breakfast but with nowhere near the success of McDonalds.  The Golden arches are the golden standard for breakfast.  A lot of McDonalds are open late night to serve the post party teenagers and many are open 24 hours.  So would you rather be utilizing your fixed assets 20-24 hours per day or 13 hours per day?  MCD prints money all day all around the globe.

McDonalds has raised its dividend 36 years in a row.  As a dividend growth investor this really appeals to me.  I own the business and I get paid.  From 1997 to 2012 the annual dividend has increased from 0.16 to $2.87.  The current payout rate for 2013 is $3.08.

The rising dividend is fueled by rising earnings.  Earnings per share have grown from $1.15 in 1997 to $5.36 in 2012.  Operating margins have increased from 25.6% in 2003 to 35.5% in 2012.  Net profit margins have nearly doubled from 10.7% in 2003 to 19.8% last year.  Their success in changing their menu to meet customer preferences is undeniable, adding coffee, wraps and dollar menu items.   Around 2006 they remodeled a lot of their locations to be more like coffee shops.  You see people hanging out there or utilizing free Wi-Fi on their laptop.  McDonalds changes with the times and profits keep going up.

McDonalds is well managed.   Any Tom, Dick or Harry with a business degree can take out a loan and open some of these other franchises (and they invariably expand too far too fast).  McDonalds wants you to have worked at a McDonalds for 7 years before becoming an owner.  Some other franchises like a Subway or Papa Johns can be had for as little as ~ $75,000.  McDonalds will cost a franchisee about $500,000 in start-up costs.  McDonalds commits you the owner to running the 1 franchise you bought, where as other franchises will allow you to open many restaurants and hire managers.  Do you see why so many other franchises fail and why McDonalds succeeds?

The funny thing is that everybody hates McDonalds and nobody eats it, yet they have served billions of hamburgers.  Soc Gen estimates that they serve 1% of the world’s population every day.  If McDonalds were an economy they would be the 68th largest in the world, ahead of Ecuador.  So yeah, nobody eats McDonalds but talk to those same people and they will tell you, “every now and then I just stop in and get a large order of fries” or “I like their McCafe coffee”.   

McDonalds is an iconic American brand, when foreigners think of American businesses, McDonalds & Coca-Cola are at the very top of a short list.  To me that is worth something.  This isn’t just any old company, this is McDonalds! 

The current valuation seems reasonable, not really undervalued, maybe fairly valued or a little overvalued.  However as a long term holding you will make money if you buy at these levels.   I added to my position at $84 when SSS worries led to a pull back at the end of last year.  I recently trimmed some around $100 but kept a core position.  The stock might be a little ahead of itself now and I’d wait for a pull back.  McDonalds is a good stock that allows you to sleep at night.  They do well in a good economy or a bad economy.

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