McDonald’s: A Once-in-a-Decade Buying Opportunity?

by Dan Burrows | July 22, 2013 12:24 pm

Another day, another disappointing data dump from McDonald’s (MCD[1]).

The world’s biggest hamburger chain’s quarterly profit and revenue missed Wall Street’s estimates, margins contracted, and the fast-food giant warned that the rest of the year will serve up only more operational indigestion.

Weakness in Asia, Europe — and, yes, even here at home — keep weighing on McDonald’s profits and sales. Increased competition in the form of supposedly healthier alternatives are also chipping away at the chain’s domestic dominance.

But we’ve seen this movie before — almost exactly 10 years ago — and if past is prologue, MCD’s current relative underperformance might be a once-in-a-decade buying opportunity.

Let’s get this out of the way up front: McDonald’s is by no means immune to economic slowdowns — not in the U.S., where folks will forgo even the cheapest of fast-food meals to save precious dollars, and certainly not overseas, where McDonald’s is comparatively expensive and often something of a treat.

Remember that Asia is slowing down markedly and much of Europe in is recession. Meanwhile, here in the U.S., the economy might be getting better ever-so-slowly, but 12 million people are still without jobs, and those that have them haven’t seen their wages rise in ages.

Even mighty McDonald’s can’t shrug off that kind of global malaise. It’s been weighing on sales and margins, and the pressure won’t let up until this epically lousy recovery shifts into a higher gear.

Adding to McDonald’s challenges in the U.S. is competition from supposedly healthier, fresher offerings, like Chipotle Mexican Grill (CMG[2]). (Ironically, McDonald’s used to be Chipotle’s biggest investor. So it goes.)

And yet for all its troubles, MCD has by no means been a dud this year. It’s not trading at valuations that say the market expects it to die. And virtually no one is shorting the stock.

True, shares in Dow Jones Industrial Average component are up just 11% on a price basis so far this year, lagging the broader market by about 8 percentage points. (The spread narrows to 7 points when factoring in dividends for both MCD and the market.)

But by both forward and trailing earnings, the stock trades in line with its own five-year averages, according to data from Thomson Reuters Stock Reports. No, it’s not especially cheap, but neither is it expensive. And if it were trading at a big discount to its own historical averages, that would signal that the market’s verdict is that growth is kaput.

Furthermore, less than 1% of MCD’s float is sold short. The beta is 0.25, meaning it’s blissfully defensive with little correlation to the broader market. Oh, and the ever-so-stable dividend currently yields 3.1% (and has averaged 3.2% during the past five years).

The last time McDonald’s stumbled like this was a decade ago. The jobless recovery following the dot-com recession wasn’t helping matters and — more importantly — the no-carb Atkins diet was all the rage. Fast-food was finished, the thinking went, and the market got pretty down on MCD. At one point, shares fell below $15.

And it was a hell of a buying opportunity for long-term investors.

Have a look at this 10-year chart comparing total returns (price gains plus dividends) for MCD and the S&P 500, courtesy of YCharts[3]:

McDonald's MCD total return[4]

During the past decade, MCD rewarded buy-and-holders with a total return of more than 500%. The broader market only doubled-and-change over the same span.

Back then, McDonald’s responded to the Atkins challenge by overhauling its menu, introducing salads, grilled chicken and other healthier fare. It’s making comparable moves today, with things like chicken wraps and egg-white substitutions for its breakfast sandwiches.

The global economy will eventually improve (although it’s going to be a slog), helping McDonald’s along the way. Yes, big upside in McDonald’s stock will require patience, but its defensive profile, generous dividend and excellent long-term track record make MCD a core holding for any equity income portfolio.

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

  1. MCD:
  2. CMG:
  3. YCharts:
  4. [Image]:

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