McDonald’s Growth Finally Cooling

“McDonald’s sales were down last month in the U.S. , and it’s the second straight month of declines. This is a chain that’s supposed to thrive in a difficult times.” — Fox Business Network 12/8/2009

McDonald’s (MCD), the world’s largest hamburger chain restaurant has long pursued global expansion aggressively and is now one of the world’s most recognizable brands. This morning, MCD released November sales data showing that the company’s restaurants underperformed across the board. Sales in stores open at least 13 months rose .7%, just about a third of the analysts’ calls for 2.2% gains overall markets. The U.S. market declined for the second straight month as continued weakness in unemployment took a bite out of breakfast and lunch traffic. Furthermore, European sales came in below expectations climbing just 2.5%. However, perhaps the most disappointing piece of information was that sales declined by 1% in the business units that include The Middle East, Asia and Africa. Those developing economies still have huge growth potential which they showed in the November period a year ago with comparable sales gains of 13.2%.

In the United States, still McDonald’s largest market, there is increasing competition from other fast food chains. Burger King (BK), Taco Bell (YUM) and others are touting cheaper items and value menus that have chipped away at McDonald’s Dollar Menu. The fast food industry’s pricing war has come at a time when consumers are highly attuned to the restraining costs where possible. As competitors take aim at McDonald’s value options, McDonald’s continues to promote their McCafe coffee drinks as a cheap alternative to competitors like Starbucks (SBUX). This morning’s report did not detail the success of that business, but it is clearly an attempt to gain market share from coffee houses and further increase McDonald’s fast food breakfast dominance.

Shares of MCD are trading down more than 2% following the news release. At Ockham, McDonald’s received an upgrade as of this week’s report to Undervalued from Fairly Valued. Even as sales come in below expectations, though some of the blame can be placed on very tough comparisons to last year, we continue to see this stock as Undervalued and this sell off only makes it more attractive. For example, McDonald’s currently sells at about 12.1x cash earnings per share, which is actually below what the market has historically been willing to pay. Over the past ten years, the market has been willing to pay price-to-cash earnings in the range of 12.3x to 17.9x.

The valuation looks very reasonable, even considering global growth may be finally slowing for McDonald’s. The market has focused on top-line growth because of today’s sales release, but we think a long term investor should primarily focus on earnings growth. We think it is reasonable to estimate (as the analysts have) that McDonald’s will grow earnings by high single digits this year and possibly low double digits next year. Long term investors should benefit from this underlying value, and MCD offers a nice yield to those that have time to wait.

McDonald’s Growth Finally Cooling

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Ockham Research is an independent equity research provider based in Atlanta, Georgia. Security analysis at Ockham Research is based upon the principle known as Ockham's Razor, named for the 14th- century Franciscan friar, William of Ockham. The principle states that a useful theory should utilize as few elements as possible, because efficiency is valuable. In this spirit, our goal is to make the investing environment as simple and understandable as possible, yet no simpler than is necessary.

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