McDonald's (MCD 0.51%) has faced some headwinds lately. Sluggish sales for the last couple of months have caused the stock price to get deep fried. In the middle of September, the stock price closed at almost $99. After bouncing around, it is off about 2%. Meanwhile, the S&P 500 is up approximately 6% during the same time frame. Investors surely must be asking if the fast food king has lost its touch. However, you should consider the fast food chain's fine merits, and consider this a buying opportunity.
The company did not become an industry leader for decades by standing still. It has done so by successfully adding new menu offerings and smartly expanding into new locations. Investors betting against McDonald's rock solid industry position because of some minor missteps may find it hazardous to their wealth.
Testing the Waters
McDonald's same store sales increased 0.5% in November. Granted, comps in the United States were down 0.8%, and in the Asia/Pacific, Middle East and Africa (APMEA) region same store sales fell 2.3%. However, Europe's same store sales increase of 1.9% more than compensated. There is a benefit to having a global presence, serving customers in more than 100 countries.
Competitive factors and flat traffic across the industry affected domestic performance, according to management. Looking ahead to 2014, the company plans to improve customer service and expand its menu offerings.
The fast food retailer recently created a "Dollar Menu and More," which is a fancy way of saying it will be charging consumers more than a buck for certain items. However, instead of merely raising the price, consumers will be getting more for their money.
For instance, there will be a Bacon McDouble, which has two beef patties, cheese, bacon, onions, ketchup, mustard, and pickles for two dollars. The Buffalo Ranch McChicken is still a dollar, or you can get bacon for a dollar more. In other words, the company did not just throw price increases at consumers, but tested in a few markets, and came up with a smart pricing strategy. In addition, the dollar menu for breakfast items such as the Sausage McMuffin remains in place.
Sound Foundation
For the first nine months of this year, total revenue edged up 1.8%, to $21.0 billion. However, earnings grew at a faster 3% clip, rising to nearly $4.2 billion. Thanks to management's commitment to buying back shares, diluted earnings per share increased 4.5%, to $4.16.
The company spent nearly $1.3 billion repurchasing its own stock this year. Although this was down from the $2.2 billion spent a year ago, it was enough to reduce the diluted share count by 1.5%.
McDonald's commitment to shareholders does not end there. Shareholders should happily note the increased dividend payouts since 2008. In fact, the company recently boosted dividends to $3.24 a share on an annualized basis, from $3.08.
McDonald's balance sheet is sound. It had over $2.5 billion in cash as of September 30. The company had $13.5 billion of total debt , but this is not a lot when compared to a market cap of $94 billion. Its debt to book equity stood at 89%. However, it operating income for the last nine months covered interest expense nearly 17 times. This very comfortable margin shows the fast food company should have no problem meeting its interest payments and lenders should be open to refinancing the obligations when these come due.
Rival Burger King Worldwide's (BKW +0.00%) balance sheet is not as strong. As of September 30, it had $764.3 million in cash and about $2.9 billion of debt. This is hefty since its market cap is $7.4 billion. Based on book equity, its debt to equity ratio is well over 200%. Still, its operating income covered interest expense by nearly 3 times. Not nearly as impressive as McDonald's, but certainly adequate.
Approximately 99% of its restaurants are franchised, as opposed to company-owned. Therefore, most of its revenue is generated from franchise fees such as a percentage of sales, franchise fees, and rental income from its properties. The franchise puts up most of the money, making it a less capital intensive business. Of course, this model limits the parent's control since franchisees own the restaurants.
Value Proposition
McDonald's is a successful company that is not content to sit on its heels, bringing new menu items and innovative pricing
Thanks to the recent pullback, the stock is trading at a P/E of 17, half that of rival Burger King. Granted, BK's earnings more than doubled to $166.9 million, but that is a lot to pay for future growth. Furthermore, McDonald's stock has a handsome dividend yield of 3.4%.
Add in a solid balance sheet and a commitment to returning cash to shareholders, and the recipe for nice stock appreciation is on the menu.
