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

by Tom Taulli | March 1, 2013 8:45 am

Once a reliable winner for investors, McDonald’s (NYSE:MCD[1]) has struggled recently. After leading the Dow in 2011, it recorded nearly a double-digit drop last year.

Keep in mind that the it’s not been easy for McDonald’s to keep up the growth, especially with the sluggishness in Europe and North America. There has also been more pressure from competitors.

Yet there are signs that McDonald’s fortunes are improving. In fact, shares have gained nearly 9% so far this year, beating the broader market.

Does that make the fast-food king a buy? To see, here’s a look at the pros and cons:

Pros

Mega Operator. McDonald’s has over 34,000 restaurants across 119 countries. Consider that the company is the destination for 69 million customers per day. A key to growth has been the franchise model, which means the McDonald’s has to front lower capital costs. In fact, about 80% of the restaurants are under some type of franchise system and the franchisees have been a great source of innovation. It’s where McDonald’s got ideas for breakout products like the Big Mac and Egg McMuffin.

Better Products. This is a huge priority at McDonald’s. Because it is harder to find new places to expand, the company needs to take away market share from competitors. Some of the new offerings include McWraps, the Cheddar Bacon Onion burger and the Grilled Onion Cheddar burger. And as for 2013, McDonald’s has a strong pipeline of new products, including the dollar-menu Fish McBites.

Focus on the Stock. Last year, McDonald’s returned $5.5 billion to shareholders through dividends and share repurchases. And yes, the company has consistently increased its dividend yield. The last was a 10% increase in September. As of now, the current yield is a solid 3.2%.

Cons

Health Movement. Even though McDonald’s has made some attempts to improve the nutrition of its menu, the fact remains that it is still full of calories. This is certainly a big problem in light of the growing epidemic of obesity and diabetes — and the growing push towards healthier foods on the consumer-end. Then, there are the concerns about the overall food supply for fast-food operators. In China, there have been reports of chickens getting too many antibiotics[2] … and then there was the case of horsemeat[3] in Europe.

Global Challenges. In January, McDonald’s global same-store sales fell by 1.9% — so it looks like 2013 will be challenging, as the U.S. and Europe continue to plod along. If anything, the elimination of the payroll tax cut in the U.S. is likely to result in lower sales for fast-food purchases. On the recent conference call, the company’s CEO indicated that the weakness is likely to continue for awhile. Another problem is that it is harder for McDonald’s to find places to expand. After all, the company already has saturated many countries across the globe.

Margins. McDonald’s is now focused on a value menu, which should help boost customer traffic. No doubt, this is likely to help deal with the slowing global growth and the impact from competition like Yum Brands (NYSE:YUM[4]), Burger King Worldwide (NYSE:BKW[5]) and Wendy’s (NASDAQ:WEN[6]). But the result will be continued pressure on margins. At the same time, McDonald’s will need to deal with higher commodity costs, especially for beef, along with rising wages in emerging markets. Interestingly, there may even be wage pressure in the U.S. because of the proposed increase in the minimum wage[7].

Verdict

Over the past decade, McDonald’s went back to its roots, focusing on its core fast-food business. To this end, the company spun-off properties like Chipotle (NYSE:CMG[8]) Mexican Grill, Donatos Pizza and Boston Market. The strategy was spot on, but the problem is that it’s getting tougher to find growth opportunities. Instead, the company is trying to find ways to increase traffic to existing stores, by expanding the menu and changing the hours.

Unfortunately, McDonald’s competition has been adopting some of the company’s successful strategies. Plus, there are the problems we mentioned with higher costs and a sluggish economy in the U.S. and Europe. In other words, McDonald’s will likely continue to face some big headwinds in 2013.

In light of this, the cons outweigh the pros on the stock for now.

Tom Taulli runs the InvestorPlace blog IPO Playbook[9]. He is also the author of “How to Create the Next Facebook[10]” and “High-Profit IPO Strategies: Finding Breakout IPOs for Investors and Traders[11].”Follow him on Twitter at @ttaulli[12]. As of this writing, he did not hold a position in any of the aforementioned securities.

Endnotes:
  1. MCD: http://studio-5.financialcontent.com/investplace/quote?Symbol=MCD
  2. getting too many antibiotics: http://investorplace.com/2013/02/yums-chinese-chicken-problem-is-overblown/
  3. horsemeat: http://investorplace.com/2013/02/horse-meat-found-in-ikea-meatballs/
  4. YUM: http://studio-5.financialcontent.com/investplace/quote?Symbol=YUM
  5. BKW: http://studio-5.financialcontent.com/investplace/quote?Symbol=BKW
  6. WEN: http://studio-5.financialcontent.com/investplace/quote?Symbol=WEN
  7. increase in the minimum wage: http://slant.investorplace.com/2013/02/minimum-wage-increase-is-good-for-walmart-and-mcdonalds/
  8. CMG: http://studio-5.financialcontent.com/investplace/quote?Symbol=CMG
  9. IPO Playbook: http://investorplace.com/ipo-playbook/
  10. How to Create the Next Facebook: http://www.amazon.com/gp/product/1430246472/ref=s9_simh_gw_p14_d0_i1?pf_rd_m=ATVPDKIKX0DER&pf_rd_s=center-3&pf_rd_r=0GRB6ZMCTYDZVNG7Q7NV&pf_rd_t=101&pf_rd_p=470938811&pf_rd_i=507846
  11. High-Profit IPO Strategies: Finding Breakout IPOs for Investors and Traders: http://goo.gl/pR2F3
  12. @ttaulli: https://twitter.com/ttaulli

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