3 Reasons Why McDonald’s Will Be Just Fine

by Lawrence Meyers | November 24, 2012 7:00 am

3 Reasons Why McDonald’s Will Be Just Fine

That sound you heard — of the earth quaking, great holes opening up in the sand, trees falling and volcanoes erupting — all as a result of McDonald’s (NYSE:MCD[1]) reporting a decline in global same store sales last week for the first time in a decade?

Well, before you have a Big Mac Attack that has nothing to do with food, I’ll get to the point: There’s really nothing to worry about. McDonald’s will be fine in the long-term — for these three reasons.

Quality Perception

The same-store sales fall comes as the company appears to be losing market share to Burger King (NYSE:BKW[2]) and Wendy’s (NASDAQ:WEN[3]), which is unheard of. The reason, though, is an issue with the fast-food king’s quality perception[4] compared to its competitors. Just think about bad publicity from films like “Supersize Me,” or from folks claiming that a McDonald’s burger can last for over a decade[5] without a change in appearance.

The good news is that the company is actively working to improve such a perception. It recently added calorie counts[6] to its menu, for example, has been adding more lower-calorie chicken options and made a promise to use cage-free eggs. As Advertising Age summed it up:

“The company is working to close the gap, people [close to the company] said, by addressing issues related to perceptions about its food’s quality, sourcing and nutritional value; sustainability practices, including suppliers’ treatment of animals; service; and condition of stores.”

New Management

At the same time, the company is under new management. So just as its quality initiatives will take time to pay off, this big change will require an adjustment-period as well.

CEO Don Thompson — who was Chief Operating Officer and has been with the company for 22 years — has a solid track record, too. After all, he’s the guy who apparently came up with the coffee drink concept and declared war[7] (successfully) on Starbucks (NASDAQ:SBUX[8]). Also, he’s apparently behind the shift from a plastic to sleek restaurant design.

His success has given him leeway to try a few things to boost revenue — things that may or may not pay off right away. But in the end, Mr. Thompson is not going to tinker with all the things that has made McDonald’s great. Plus, the company is akin to Walmart (NYSE:WMT[9]) in that raw material procurement and economies of scale give it a massive advantage over competitors.

Focus on Margins

Finally, while the same-store sales slip is alarming, McDonald’s seems to be pushing big-ticket items as opposed to the products that usually drive customer sales, like dollar menus and coffee drinks. Obviously, this leads to lower volume but higher profit margins.

And at the end of the day, profits are king.

To that end, McDonald’s is trading at about $86, off its high of $102. Analysts see 12% compounded growth over the next five years, including dividend reinvestment. Giving the company a premium to the point where it deserves a 14x multiple, then 2017 earnings would be $9.81. Fair value in 2017 would be $137. That’s a very reasonable return and probably a good buy at this point.

It’s been a rough year for the Golden Arches, but don’t count the fast-food leader out quite yet.

As of this writing, Lawrence Meyers did not own a position in any of the aforementioned securities, but has extended family members who own franchises.

Endnotes:
  1. MCD: http://studio-5.financialcontent.com/investplace/quote?Symbol=MCD
  2. BKW: http://studio-5.financialcontent.com/investplace/quote?Symbol=BKW
  3. WEN: http://studio-5.financialcontent.com/investplace/quote?Symbol=WEN
  4. quality perception: http://adage.com/article/news/mcdonald-s-losing-lovin-feeling/232821/
  5. last for over a decade: http://aht.seriouseats.com/archives/2008/09/12-year-old-mcdonalds-hamburger-still-looking-good.html
  6. added calorie counts: http://investorplace.com/2012/10/mcdonalds-hungry-for-new-offerings/
  7. declared war: http://www.google.com/imgres?imgurl=http://4.bp.blogspot.com/_7s_uBh9GuYw/SU5sjVFaH7I/AAAAAAAAASQ/5uAMUhVCKg8/s320/fourbucks.jpg&imgrefurl=http://dannygamache.blogspot.com/2008/12/four-bucks-is-dumb.html&h=219&w=292&sz=20&tbnid=ZcXrEq3rTbJvjM:&tbnh=92&tbnw=123&prev=/search%3Fq%3Dfour%2Bbuck%2Bis%2Bdumb%26tbm%3Disch%26tbo%3Du&zoom=1&q=four+buck+is+dumb&usg=__XNdJvoMHXh5do_5t_7DpkYV24EM=&docid=RbKKRmAYI6KNTM&sa=X&ei=2NOqUKS9JKH9iwLl0IGYDA&ved=0CEUQ9QEwBQ&dur=3200
  8. SBUX: http://studio-5.financialcontent.com/investplace/quote?Symbol=SBUX
  9. WMT: http://studio-5.financialcontent.com/investplace/quote?Symbol=WMT

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