In December of 2011, in this space, we opined that McDonald’s (MCD – Free McDonald’s Stock Report) shares were looking a little pricy despite the fact that the fast-food giant is universally viewed as a great company. Since January, the shares have largely traded lower, a fact that is clearly visible on the Graph. While not a screaming buy at current levels, it would certainly be worthwhile for conservative, income-oriented investors to keep an eye on the stock.
McDonald’s Good Side
One of the most impressive aspects of McDonald’s is the strength of the fast food giant’s concept. Not only is the McDonald’s name ubiquitous in the United States, but it is known the world over. In fact, as the Business Description notes, the company derives about two-thirds of its revenue from abroad. Indeed, the company may be seen as all-American, but it really is a global giant. A major factor in its successful global expansion has been the value proposition of its offerings, which allowed it to achieve impressive performance numbers during the 2007 to 2009 recession.
Moreover, with almost $2.5 billion in cash (as of June; noted in the Current Position box) and a reasonable debt level of about 50% of the capital structure (found in the Capital Structure box), it’s no surprise that McDonald’s earns Value Line’s highest Financial Strength rating of A++. This number, coupled with the highest score for Stock Price Stability rating (100) leads to a Safety Rank of 1, also the best possible. (The two ratings can be found in the Ratings box, while the Safety Rank can be found in the Ranks box.) It also boasts solid dividend and earnings growth rates, found in the Annual Rates box, as well as impressive historical metrics on these measures. There is clearly a lot to like about McDonald’s.
McDonald’s Less Good Side
As Value Line analyst Mathew Spencer points out in the Analyst Commentary, recent performance at McDonald’s has been less than spectacular. Moreover, he expects the relatively weak showing to linger through the end of the year. This has resulted in him trimming 2013 estimates, as well. So, despite the company’s resilience through the recent recession, it appears that it is stalling out a little bit. Even with the expectation of weaker performance, though, Spencer still anticipates 2013 earnings to come in at $6.00 per share. (This figure can be seen in the Statistical Array.)
He is less positive about the longer-term prospects, as well, trimming his projected growth rates for both earnings and dividends slightly, to annualized rates of 8.5% each (found in the Annual Rates box). It is clear that McDonald’s outlook is not quite as bright as it was just a year ago. This is largely the reason for the share price decline, which has brought the stock price back in line with Value Line’s cash flow line (the solid line of the Graph).
The cash flow line is created by taking a “best fit” multiple of cash flow per share that allows the line to roughly track the stock chart. This, then, is the multiple of cash flow that investors are willing to pay for the stock. Visually, when the shares are trading above the line they are likely overvalued and when trading below the line they are viewed as undervalued. The dotted lines at the end of the cash flow line are based on Value Line’s proprietary estimates.
A quick look at the Graph, than, can tell a lot about a company’s valuation. In McDonald’s case, it was deeply undervalued based on the Cash Flow Line in 2002 and 2003. It traded close to the line through 2011. But, based on Value Line’s estimates at the time, it was trading well above the line in late 2011. This is what led to the statement that it appeared richly priced. Only now, some nine months into 2012, are the shares trading close to the cash flow line. That said, the shares are still slightly above that line and the relative P/E (found in the Top Label section) is at the high end of its recent range. So McDonald’s is cheaper than it was, but it’s more likely fairly valued than “cheap.”
One to Keep an Eye On
A good, some might argue great, company isn’t always a good investment. The market, however, is always in flux and shares of good companies often bounce around a fair amount in a year. Value-oriented Investors should keep an eye on McDonald’s shares, because a good investment opportunity may be presenting itself. Indeed, with results expected to be relatively weak over the next six months or more, there could be more share-price weakness ahead—and an even better buying opportunity.
At the time of this article's writing, the author did not have positions in any of the companies mentioned.