McDonald's: Not for the Shortsighted Investor

If you're looking to invest in a company that's likely to see significant stock appreciation in 2014, then you're probably in the wrong place. On the other hand, if you're looking to invest in a company that offers tremendous scale, marketing power, future global expansion opportunities in emerging markets, strong leadership, and significant cash flow that leads to share buybacks and generous dividend payments, then you might want to consider McDonald's (NYSE: MCD  ) .

Let's take a look at its strategy to drive the top line in the future as well as what the company can do for investors now.

Strategy for long-term growth
McDonald's has already announced that its top-line growth is likely to be muted in 2014. That's because it will take time for the company's current strategies to take effect fully. Also keep in mind that implementing these strategies will lead to increased costs, as will the opening of 1,500 to 1,600 new restaurants and marketing related to the Winter Olympics in Sochi, Russia. Therefore, once again, don't expect the world from McDonald's over the next year.

The aforementioned strategies pertain to offering broader menu items at different price points throughout all dayparts, modernizing restaurants, increasing customer engagement, digital enhancements, and more.

Comps breakdown 
You might already be aware of McDonald's comps performance in November. On a year-over-year basis, comps improved 0.5% overall, but the geographic breakdown wasn't impressive. For instance, comps declined 0.8% in the United States and 2.3% in APMEA (Asia-Pacific, the Middle East, and Africa). However, comps improved 1.9% in Europe.

The poor performance in the United States related to fierce competition. If you think back 20 years ago (if you're old enough), when you went out for a quick bite to eat, you likely either went to McDonald's or Burger King  (NYSE: BKW  ) . If you were a real rebel, then you opted for Wendy's (NASDAQ: WEN  ) . But you weren't going to Chipotle Mexican Grill, Qdoba Mexican Grill, Panera Bread, or Buffalo Wild Wings.

McDonald's is now facing competition from all angles domestically, and it must deliver in a big way in regard to menu offerings and store remodels in order for that to change. The good news is that McDonald's is capable of accomplishing this feat. It has fought off numerous headwinds in the past.

The poor performance in APMEA primarily stems from Japan. Growth potential still exists in many other areas, and McDonald's plans on broadening its accessibility, enhancing its value, and offering more localized menu items throughout these regions. I would bet on McDonald's showing improvements in APMEA, but that's just my opinion.

All is well in Europe, especially in Russia, the United Kingdom, and France, where demand is high. Germany is the one weak spot. Value-menu items and promotions are playing a big role in the company's success in Europe, which shouldn't come as a surprise given the austere and debt-ridden environment, which has led to an overly cautious consumer.

Now let's talk about valuation and cash flow.

It's all about the cash flow
McDonald's generated $7.1 billion in operating cash flow in the past year. That's a difficult number to fathom. To put that into at least some perspective, Burger King Worldwide generated $347.5 million and Wendy's generated $318.48 million in operating cash flow over the same time frame.

By generating this much cash flow, McDonald's is able to heavily reinvest in its business. All leftover free cash flow goes to investors in the form of buybacks and dividends. Buybacks lead to an improved bottom line, and McDonald's currently yields a generous 3.3% dividend. Comparatively, Burger King yields 1.3%, and Wendy's yields 2.3%.

When it comes to valuation, McDonald's is appealing compared to its peers, trading at just 16 times forward earnings, whereas Burger King and Wendy's are trading at 22 and 29 times forward earnings, respectively.

Also consider how consistently McDonald's top line outpaces its SG&A expenses. This is the sign of a well-run company: 

MCD Revenue (TTM) Chart

McDonald's revenue (trailing-12 months) data by YCharts

The bottom line
McDonald's is likely going to look a lot different five years from now in regard to menu items and decor. However, it should remain the same in regard to methodical stock appreciation (pullbacks possible) and generous capital returns to shareholders in the form of stock buybacks and dividends. That's a net positive for long-term investors. 

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  • Report this Comment On December 15, 2013, at 7:41 AM, Mathman6577 wrote:

    Good point regarding operating cash flow.

    I was a little disappointed it didn't use more of it to increase the dividend more this year.

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