Sunday, April 03, 2005

Investment Roundtable - McDonald's Corp. (NYSE: MCD)

We are dusting off the ‘ol Investment Roundtable this week and analyzing a favorite of most Americans. I’m speaking of a true American company. Not only is this company the largest fast-food restaurant in America, but the world. I’m obviously talking about McDonald’s Corp. (NYSE: MCD).

MCD is currently trading at $31/share with a market cap of around $39.4 billion. As Standard and Poor’s tells us, "With one of the world’s most widely known brand names, McDonald’s serves about 49 million customers daily. The company operates and licenses more than 31,000 restaurants in about 120 countries. At December 31, 2004, there were 13,673 McDonald’s restaurants in the US, and 16,823 elsewhere."

"McDonald’s restaurants offer a substantially uniform menu, including hamburgers, french fries, chicken, fish, specialty sandwiches, beverages, and desserts. Most units also serve breakfast. To capture additional meal occasions, the company operates and franchises more than 1,000 restaurants under its Partner Brands concepts: Boston Market and Chipotle Mexican Grill. MCD also has a minority interest in a UK-based quick service food concept, Pret A Manager."

It’s long been asked how many more McDonald’s could they possibly put up in a county/city/state/country? Well, McDonald’s keeps defying the odds and growing. MCD continues to grow from their ability to be flexible in many different situations. People are eating healthier (supposedly…I have my doubts) and now MCD offers many substitutes to the hamburger and the big fat/calorie items. The parents can still make their kids stop hitting each other in the car by getting some happy meals and they can also feel good about themselves by picking up a salad, some fruit, etc. MCD is even trying to make it easier for the parents to purchase happy meals by allowing substitutes of fruit and milk for fries and pop.

A new growth area for MCD is their new Chipotle restaurants. I must say that I am not a big fan, but everybody else I know loves this restaurant with their overly huge Mexican fare. So, right next to every McDonald’s could now be a Chipotle. It seems that MCD will also begin testing a line of premium coffees at its US stores in 2005 and 2006. I will never doubt McDonald’s in its ways to garner a few extra percentage points of growth.

Now let’s take a look at the value criteria that Benjamin Graham, the father of value investing, was fond of:

P/E 17.3 =Yes, Benjamin Graham criteria requires a P/E at least below 20

Price/Book 2.78 = No, BG criteria requires a P/B below 1.5

Current Ratio 0.8 = No, BG criteria requires a CR above 2.0

Revenue Growth 7.12% = No, BG criteria requires RG to be above 15%

Intrinsic value $31.90 (S & P Fair Value Calc) = No, S&P believes MCD is pretty fairly valued

Yield 1.8%

I'll also add some price targets since I have them right in front of me...

Standard and Poor's: $38.00 12-Month Target Price (22.5% appreciation expected)
Value Line: 2008-2010 Price Projection between $40 and $50/share (33.33% and 66.66% appreciation)

McDonald's passes 1 out of 6 of our Benjamin Graham criteria giving MCD's a 16.66% score. I don't believe MCD's is a value stock at these levels. Let's go over and see what our friends over at nasdaq.com think about good 'ol McDonalds.

Here is what the Guru page over at Nasdaq.com had to say in regards to MCD being a value investment based on BG criteria:

Guru Score: 43%

SECTOR: [PASS] MCD is neither a technology nor financial Company, and therefore this methodology is applicable.

SALES: [PASS] The investor must select companies of "adequate size". This includes companies with annual sales greater than $340 million. MCD's sales of $19,064.7 million, based on trailing 12 month sales, pass this test.

CURRENT RATIO: [FAIL] The current ratio must be greater than or equal to 2. Companies that meet this criterion are typically financially secure and defensive. MCD's current ratio of 0.81 fails the test.

LONG-TERM DEBT IN RELATION TO NET CURRENT ASSETS: [FAIL] For industrial companies, long-term debt must not exceed net current assets (current assets minus current liabilities). Companies that do not meet this criterion lack the financial stability that this methodology likes to see. The long-term debt for MCD is $8,357.3 million, while the net current assets are $-662.7 million. MCD fails this test.

LONG-TERM EPS GROWTH: [PASS] Companies must increase their EPS by at least 30% over a ten-year period and EPS must not have been negative for any year within the last 5 years. Companies with this type of growth tend to be financially secure and have proven themselves over time. MCD's EPS growth over that period of 30.8% passes the EPS growth test.

P/E RATIO: [FAIL] The Price/Earnings (P/E) ratio, based on the greater of the current PE or the PE using average earnings over the last 3 fiscal years, must be "moderate", which this methodology states is not greater than 15. Stocks with moderate P/Es are more defensive by nature. MCD's P/E of 17.56 (using the current PE) fails this test.

PRICE/BOOK RATIO: [FAIL] The Price/Book ratio must also be reasonable. That is, the Price/Book multiplied by P/E cannot be greater than 22. MCD's Price/Book ratio is 2.82, while the P/E is 25.30. MCD fails the Price/Book test.

McDonald's doesn't seem to be a value play as Benjamin Graham would describe one.

That being the case; with MCD's planning to return $1.3 billion to shareholders through share repurchases and dividends, continual increases of the dividend, a continually aggressive debt repayment schedule, and an addictive menu, I believe McDonalds requires another look to the long-term investor.

Now, let's take a gander at what the charts are telling us. The first chart below is a monthly view of MCDs:


Click to View MCD Monthly Posted by Hello

You might be able to see what is exciting me on the technical front. Staring at us right in the face is a seemingly huge inverted head and shoulders pattern. This pattern suggests that MCD will trade to a cycle high of around $47/share. As a technical analyst you should never give both price and time projections so I am not sure when this cycle high will be achieved, but this level offers capital appreciation of 56.67%.

In the big capitalization world of the Dow 30 you can't ask for much more then that.

You will also notice MCDs coming off from previous highs and maybe going to pullback to the neckline. That seems logical, but let's see what the shorter term views are saying about that possibility.


Click to View MCD Weekly Posted by Hello

Now, we are glaring at the weekly view of MCD. MCD is getting to oversold levels according to the Stochastics, but still has some room according to the RSI. The weekly view is telling us that a re-touch of the neckline could be quite possible. That touch might coincide with a touch of the 50-week moving average as well.


Click to View MCD Daily Posted by Hello

Looking at the daily view, it becomes much less clear if MCD will pullback to the neckline. Both the Stochastics and RSI are looking to be at oversold levels. The weekly view has more weight than the daily so what might happen here is another try to move higher might be met with overhead supply. That overhead supply would then act as a catalyst to send MCD back down the the 200-day moving average (same line as the 50-week MA).

Our goal here is to purchase shares at the neckline if at all possible. This would, in fact, be possible with a put selling strategy. You might want to go over to billcara.com to find out more about this strategy. I'm still a beginnner with options as well.

Please check out my other partners that will be contributing to the Investment Roundtable this week:

Tom Ott over at Sixth World Gazette

Harry over at Jaloti

Ron over at Chart Student (His new blog)

Best Regards,

The Soothsayer of Omaha

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