Stock of the Day - March 2, 2009 - MCD

McDonald's Corporation (MCD)

McDonald’s (MCD), home of the Big Mac, Chicken McNuggets, and those unbeatable french fries. What once was a small American burger joint quickly expanded to become the world’s largest fast food restaurant business. The golden arches are now an international symbol for tasty, yet cheap eating. So should McDonald’s be a part of your investment portfolio?

We don’t have to worry about the popularity of McDonald’s restaurants. Fast food has become an integral part of American culture. People love nothing more than quick and delicious food at a low cost. There are currently over 35,000 McDonald’s restaurants in over 100 countries, and the gigantic franchise currently has a market cap of $58.18 billion.

McDonald’s has done a lot throughout the years to update its image and remain current. The company has eased the worries of health-concerned individuals by providing alternatives like salads and apple slices. Two years ago, the company introduced its drip coffee to the breakfast menu. As a terrified Starbucks (SBUX) looked on, McDonald’s steadily gained market share in the coffee market. Coffee sales have increased 70% since its introduction, and McDonald’s receives an added benefit from customers who come for coffee and leave with other breakfast items.

The main source of expansion for MCD is overseas growth. In fact, the company brings in 65% of its revenue from restaurants overseas! McDonald’s has proven to be incredibly popular in Europe and most recently in China. In a period of time when most companies are closing stores and laying off employees, McDonald’s will be opening 500 restaurants and hiring over 12,000 workers.

Many people believe that McDonald’s has proven itself to be ‘recession resistant’ or even recession ‘proof.’ Individuals that used to go out to eat at middle tier restaurants such as California Pizza Kitchen (CPKI) and The Cheesecake Factory (CAKE) may opt for a cheaper meal under the golden arches. McDonald’s’ same-store sales increased by 7% worldwide in January. People simply love McDonald’s famous dollar menu for its price value. I’m skeptical of the term ‘recession proof,’ because I don’t believe that any company can fully resist the effects of the macroeconomy. With that said, I do agree that McDonald’s has a competitive advantage in a recession.

The company definitely could not avoid one major factor of the macroeconomy: the rallying dollar. Interestingly, the rising value of the U.S. dollar spelled bad news for McDonald’s in the last quarter. Net income fell 23% to $985 million as revenue fell 3% to $5.57 billion. The higher U.S. dollar affected these drops because it diminished the revenue of McDonald’s international business through steeper exchange rates. More recently, however, the dollar has started to lose speed against other currencies. As other currencies gain value, so will business for McDonald’s.

Despite all of the good news, one recent trend is troubling. Insiders have been dumping their shares in the past 6 months. Executives and managers working inside the corporation have sold off about 160 million shares. While the catalyst behind the selling is unknown, insider selling generally spells bad news because it gives management less incentive to keep the stock price of the company high.

My main concern for MCD is the value that stockholders are currently giving the company. McDonald’s is currently trading at about 14 times earnings and has a PEG ratio of 1.5. Its main competitor, YUM! Brands (YUM), is trading around 13 times earnings and as a PEG ratio of 1.07. These numbers indicate that investors may be giving McDonald’s more value than the company deserves (P/E ratio and PEG ratio were both previous Trillionaire Terms of the Day). Investors are essentially paying a premium for the value of the McDonald’s brand and future growth.

The main question becomes: Is the stock worth the extra premium? We’ve learned that McDonald’s is enormous in both size and popularity. The company is constantly evolving internally while expanding internationally. MCD was one of two stocks in the Dow Jones Industrial average that actually increased in value in 2008 (the other was Wal-Mart (WMT)). We know the company can survive, if not thrive, in a down economy. All else aside, McDonald’s will always retain value from its brand name and the reputation that goes along with it. Even though we do not know the motivations behind insider selling, all of the benefits appear to outweigh possible disadvantages.

The stock is near its 52-week low price point and is currently trading in the low $50s. The situation surrounding McDonald’s makes for a tough call. If you’re in the investment for the long run, the company definitely presents a great ‘buy and hold’ opportunity. Despite this, I doubt that the stock has seen its bottom and I would not be surprised if the stock price continued to move downward throughout the next few months.  I’d rank MCD to be a conservative buy as of right now because of a beneficial 3.8% dividend yield, but definitely be on the lookout for opportunities in the near future to pick up the stock at a better price.

Matt Schwartz

College Trillionaire