McDonald’s (MCD: Charts, News, Offers), the world’s most well-known fast food chain, has been a rare bright spot in the souring stock market lately. As the rest of the market plunged, MCD rose to 52-week highs, with all signs pointing towards a breakthrough soon. Yet some bearish market pundits have claimed that MCD has gotten ahead of itself, due to fears regarding rising commodity prices, as evidenced by the recent spike in wheat due to Russia’s ban on grain exports. Lowered raw commodity prices in the first half of 2010 boosted McDonald’s bottom line, and analysts had based their lofty earnings expectations for the second half on their continued decline. Now, with a game-changing grain ban wreaking havoc on world markets, can McDonald’s continue growing?
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Stock Analysis
Technically, this stock is still on fire. There haven’t been full pullbacks to give new investors an entry point, which has fueled MCD’s rise to all-time highs. The forward P/E of 14.9 and the PEG of 1.59 suggest that there is still room to grow, based on analyst estimates. The quarterly dividend of 0.55 yields 3%, and is another reason many conservative investors have placed their cash in MCD; it is one of the safest brands for a bear market and yields more than most savings accounts across America. Any pullbacks for long-term investors would be offset by dividend reinvestment and dollar-cost averaging, making MCD a very attractive stock to both individual and institutional investors.
On August 9, McDonald’s announced some big growth numbers. Same store sales in the US climbed 5.7%, 5.2% in Europe and 10% in Asia, Africa and the Middle East, for an average of 7% growth globally. Net income increased in the most recent quarter by 12% to 1.2 billion. The depreciation of the Euro and other currencies had little overall impact on its profits. If the USD continues to rise against other currencies, however, an slight erosion of international profits is possible.
McDonald’s main profit engine is international. The American market, which has long been saturated, only comprises a small part of McDonald’s overall revenue. Its main developed markets include the U.K., Canada, South Korea and Australia, but much of its growth comes from emerging markets, most notably China, India, Eastern Europe and the Russian Federation. McDonald’s strategy to capitalize on emergent middle classes is the key to its success. In addition, many emerging markets do not associate McDonald’s with the unhealthy, obese stigma that it has come to represent in North America, a factor that almost sunk the company prior to 2003. It also extended store hours in urban areas to 24 hours and added drive-thru services in China. In addition, almost 80% of McDonald’s restaurants are franchised rather than store operated, which provides safe, steady income with little overhead.
Despite clean business metrics, the question of the Russian grain export ban’s ultimate impact is an unknown variable that could adversely affect McDonald’s during the second half of 2010. The drought-induced ban from the world’s fourth-largest exporter, which includes wheat, corn, barley, rye and flour, will be in effect from August 15 to the end of the year. This ban, combined with poor weather conditions in Eastern Europe and Canada, have increased speculation that wheat, corn and soybean prices would all rise, and their futures have risen 68%, 29% and 13%, respectively. These all point towards higher feed grain costs which would curb livestock exports in North America and Europe, which would hurt McDonald’s domestic and global margins significantly. Analysts are still projecting 13% growth for MCD in 2010 and 8.2% growth in 2011, which are high expectations that may be hard to meet given the commodities situation.
While these primary commodities are very important for the production of buns, starches and meats, they are not as essential for beverages. McDonald’s rapidly expanding drink menu, which has recently been focused on a larger, cheaper coffee line to rival Starbucks (SBUX: Charts, News, Offers), is responsible for a huge percentage of its increasing margins. If McDonald’s can keep bringing in the revenue from its beverages, it has a good chance of continuing its growth despite rising commodity prices. In addition, a recessionary, bear market environment has benefited McDonald’s in the past, as cash-strapped consumers have shifted towards cheaper food products.
McDonald’s is still one of the best long-term investments in the current market. Its international growth is strong, and offers a defensive hedge against uncertain retail, tech and energy sectors. It is well positioned to outlast the current commodities crisis and increase margins going into 2011-2012.
Other News About MCD
- McDonald’s yuan bonds in HK see strong demand – Is this the start of McDonald’s big push?
- McDonald’s and Wendy’s Top List of Worst Fast Food Kids’ Meals – Health concerns return
Other Stocks in the News
- Oppenheimer Lowers Burger King Estimates – How can Burger King (BKC: Charts, News, Offers) stay competitive?
- Wendy’s Plans to Open International Restaurants – Wendy’s (WEN: Charts, News, Offers) attempts to revisit international expansion to follow McDonald’s and Yum! Brands (YUM: Charts, News, Offers)
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Leo Sun is long-time market follower and finance writer. He regularly contributes to the Stock of the Day analysis.
