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Should I Buy McDonald’s? 3 Pros, 3 Cons

Core holding looks a bit pricey to buy more at current levels

   

Blame it on the mango pineapple smoothie. McDonald’s (NYSE:MCD) did.

The world’s biggest fast-food chain suffered a sharp selloff in its stock Wednesday after July sales at stores open at least 13 months came in flat versus the year-ago period. McDonald’s, a component of the Dow Jones Industrial Average, blamed the crummy global economy, as well as the popularity of a mango pineapple smoothie it introduced last summer, which set sales up against difficult comparisons.

Smoothies aside, the glow is starting to dim on the Golden Arches. Same-store sales, a key industry metric, missed Wall Street’s forecast by 2.3 percentage points, hurt by the sluggish U.S. and European markets, as well as Asia, the Middle East and Africa — traditionally faster-growing markets for McDonald’s.

It used to be that McDonald’s, with its popular and low-cost fare, was thought to be recession-proof. The stock certainly was throughout the market crash and recovery. During the past five years, MCD never dipped into the red. And while the S&P 500 still is nearly 4% below its August 2007 level, McDonald’s is up 80% over the same span.

But sluggish global economic growth, a stronger dollar and competition from rivals are starting to take their toll. McDonald’s missed the Street’s bottom- and top-line estimates when it reported second-quarter results last month, the first such misses in more than two years.

Shares are off more than 11% year-to-date, lagging the broader market by 23 percentage points. So, should you buy McDonald’s stock on weakness? Let’s have a look at the pros and cons:

Pros

Dividend Stalwart: McDonald’s has been a core equity income holding for decades — that’s why it makes InvestorPlace’s list of Dependable Dividend Stocks. Indeed, it has a history of consistent, rising payouts going back to 1976. Like bonds, a dividend stock’s yield and price move in opposite directions, and this year’s selloff has McDonald’s dividend yielding a very tasty 3.2%.

Total Return: Yes, when it comes to analysts, they say you don’t need them in a bull market, and in a bear market they’ll wipe you out. Still, there is something to be said for discounted cash-flow analyses and the wisdom of crowds. The median price target on MCD from 32 analysts surveyed by Thomson Reuters comes to $100 a share. Add in the yield on the dividend, and the projected total return comes to 17.5% in the next 12 months or so.

Been There, Done That: McDonald’s has been written off before, only to bounce back and generate strong returns. The company has a great track record at innovation, adjusting its menu and stores to deal with tough times. The stock sold off hard in the aftermath of the dot-com recession, hurt by the rise of everything from Starbucks (NASDAQ:SBUX) to the Atkins diet. By early 2003, MCD was going for less than $13. Giving up the name was a mistake. The stock is up 600% since then on a price basis alone.

Cons

Not Recession-Proof, After All: You know times are tough when even McDonald’s is having a hard time getting folks into its stores, especially in the U.S., where its prices are much lower compared with its restaurants overseas. Sales at McDonald’s domestic locations dropped 0.1% in July, missing Street forecasts for a 2.2% gain. Indeed, Americans were so tight-fisted last month, McDonald’s posted its worst U.S. sales figures since January 2010.

Strong Dollar: MCD derives a majority of its revenue from overseas, making it vulnerable to currency exchange. The stronger dollar caused second-quarter earnings to decline 4.5%. Strip out the effects of forex, and profit would have ticked up 1%. That’s more than a 5% swing on currency alone. The European debt crisis makes it hard to see how the dollar can get cheaper anytime soon.

Valuation: Even after MCD’s 2012 decline, shares still look pricey compared to the broader market and the company’s own growth prospects. The stock currently sports a forward price-to-earnings ratio of 14.4, which is more than 7% higher than the S&P 500. However, the broader market has a long-term growth forecast of more than 10%, while MCD stands at about 9.5%, meaning it probably doesn’t warrant that premium valuation.

Verdict

MCD’s dividend and total return history makes it a core holding for any long-term equity-income portfolio. But there’s no sense initiating a position at current levels. Shares look a tad pricey. The year-to-date selloff is partly just payback for a long streak of outperformance and overvaluation.

So should you buy McDonald’s? No — for now, you’d be better off waiting for the valuation to lose its premium.

As of this writing, Dan Burrows did not hold a position in any of the aforementioned securities.


Article printed from InvestorPlace Media, http://investorplace.com/2012/08/should-i-buy-mcdonalds-3-pros-3-cons-3/.

©2014 InvestorPlace Media, LLC

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