McDonald's (NYSE:MCD), like many consumer discretionary stocks, has had a slow first half of 2013, and that trend looks to continue for the near term. McDonald's expects its global comparable sales to remain challenged throughout the year. On the bright side, McDonalds, like any component of the Dow Jones Industrial Average (DJINDICES:^DJI), consistently returns value to shareholders. Because of that return and its large competitive advantages, including its brand power and low-cost position, is this a good time for investors to jump aboard the Golden Arches?
Ronald gets a makeover
You often hear in business classes, "Adapt or die," and that's precisely the decision McDonald's faces. That doesn't mean McDonald's is a failing business; it's a cash-flow-producing machine that consistently improves its top and bottom lines. However, it does need to adapt its stores and menu to maintain current consumers and attract new ones, thus sustaining its growth.
That's especially true with regard to my generation, the Millennials. I grew up eating McDonald's and did so for a decade. Fast-forward to today, and I haven't eaten at McDonald's in years, and I don't plan to make a trip anytime soon. I'm not alone, and McDonald's has clearly lost some allure for my generation. The company's recent store makeovers are an attempt to adapt and modernize its restaurants to bring consumers like me back to the Golden Arches -- see below.
That's an impressive effort to modernize a restaurant that has long been known for plastic seats and swiveling chairs. McDonald's plans to spend more than $3 billion to open 1,500 to 1,600 new restaurants globally, and it plans to reimage another 1,600 locations.
There's more to the equation, though: As the U.S. market reaches saturation, McDonald's needs to upgrade its menu to drive comparable-store sales.
During the recent recession, McDonald's was able to use competitive advantages to stay impressively profitable. Its brand image drew consumers in, and its low-cost position enabled it to deliver value to those consumers. Now, as the economy has gradually improved and consumers are spending more, McDonald's has struggled to graduate more of those consumers from the dollar menu, which still represents 13% to 14% of sales.
This problem has been amplified because of competition that is offering a more premium product at a decent speed and price – the new fast-casual style restaurants. As Chipotle and Panera continue to thrive in this new segment, McDonald's will need to innovate new menu items to compete.
One idea could be borrowed from McDonald's Australian chain, the Dinner Box, which has been successful not only in Oz but also in several European markets. Another idea is to bring the European 1955 Burger -- which is topped with caramelized onions, bacon, and a German-style BBQ sauce -- to America. There are also discussions of "Shaker Fries," which would be a small shaker bag with fries and a packet of seasoning. The list of possibilities goes on, but only time will tell whether McDonald's can come up with more successful menu items.
McDonald's consistently reduces its outstanding shares while continuing to deliver revenue and earnings growth. In addition to its share buybacks, it consistently improves its dividend payout, which is what draws many investors to the stock.
The dividend increases will likely keep coming as McDonald's continues to turn its low-margin company-owned restaurants into high-margin franchises here in the U.S. market. When that happens, it frees up capital for additional share buybacks or increased dividends. And it gets even better: Even when the company-owned store is sold, McDonald's typically retains the rights to most of its buildings and property, and that remains on the books at cost -- meaning the company owns a plethora of undervalued real estate.
If McDonald's proves it can adapt through modernizing its stores and upgrading its menu, it could provide an excellent opportunity for long-term investors. The downside in owning McDonald's is limited, as its brand image and low-cost position will continue to provide strong cash flow and earnings even during rough times; the Golden Arches aren't going anywhere. If you're looking for exciting growth stocks, you missed the boat on McDonald's. However, If you're looking for a strong, financially stable company that consistently returns value to shareholders and still has remaining sales growth globally, McDonald's looks like a solid investment for you.