Weary consumers still flock to McDonald's

In a down economy, consumers’ loss might be the world’s leading fast-food chain’s gain.

With a stock price that has been climbing since mid-May and an expensive product rollout underway, McDonald’s Corp. is defying the recession despite—or perhaps because of—tightened consumer spending. As cash-strapped customers opt for a cheaper meal, the only thing the Golden Arches may have to worry about is an economic upturn.

With 31,000 restaurants worldwide and a sector-leading market cap above $66 billion, McDonald’s is trouncing the competition. The Oak Brook-based restaurant chain’s stock closed Tuesday at $60.38 and is projected to reach $64.85 during the next year, according to 13 analysts surveyed by Bloomberg LP. The stock hit its 52-week high of $67 on Aug. 11 and its low of $45.79 on Oct. 10.

Contrast that with Burger King Holdings Inc., which closed Tuesday at $16.23, down more than $14 from its 52-week high of $30.95 on Aug. 11.

McDonald’s price-to-earnings ratio is 16.24, richer than Burger King’s P/E of 11.46, and the Standard &Poor’s 500 index’s P/E of 15.41.

For the quarter ended March 31, McDonald’s reported $979.5 million in net income, a 3.5 percent increase from the year-earlier period, despite taking a hit overseas, where an appreciating dollar made foreign transactions more expensive. Its same-store sales rose 6.9 percent worldwide in April.

Market watchers believe the recession may be helping McDonald’s, which is able to offer lower prices than its rivals.

“The economy right now is actually one of the things that makes McDonald’s desirable,” said Janna Sampson, co-chief investment officer at OakBrook Investments LLC, which owns more than 300,000 shares of the stock. “It has a slightly less cyclical bent than many discretionary stocks [and] does a good job of offering a product at a very good value point, much like Wal-Mart.”

McDonald’s cheap selection, including its Dollar Menu, has attracted consumers looking to fit eating out into their dwindling budgets.

“They’ve benefited from consumers trading down,” said Jack Russo, an Edward Jones & Co. analyst, who has a hold rating on the stock.

The company’s evolving image has also helped, as more and more consumers associate the fast-food giant with salads and wraps as well as cheeseburgers and french fries.


One of McDonald’s biggest advantages over competitors is its unmatched ability to negotiate with suppliers. Last quarter, McDonald’s selling, general and administrative expenses, which cover supply costs, accounted for 13.5 percent of the company’s total operating expenses, about 8 percent lower than Burger King.
“There are a number of suppliers in the food industry whose existence is dependent on McDonald’s,” R.J. Hottovy, a Morningstar Inc. analyst, said. “The fact that they purchase more than anybody out there usually affords them discounts.”

Hottovy estimates McDonald’s fair value at $63 and gives the stock four out of five stars, a “very optimistic” rating, he said.

“You can’t afford to lose the McDonald’s account,” said Sampson, who credits the company with managing costs better than “many if not all of its peers.”

Bargaining power is an important asset in tough economic times.

“In a difficult environment, they can come in and ask for price concessions [because] their size just dwarfs everybody else,” Sampson said.

With such a wide competitive edge, McDonald’s stock will likely hit—and might even exceed—its $64.85 one-year target price, analysts said. But there are some potential pitfalls. For one, investors who have flocked to the company as a sure bet in the recession might want to take bigger risks when the economy stabilizes.

“It’s a flight to safety,” said Hottovy, who called McDonald’s “essentially a [Treasury] bill for the restaurant industry.” As investors regain an appetite for risk, Hottovy said, “people might start to move away.”

There is also a chance that consumers currently trading down for a Big Mac or a specialty coffee from the McCafé—the company’s recent aggressive push into Starbucks Corp. territory—might revert to more expensive options as the worst of the recession passes.

“As the economy picks up, there’s probably a group of people that will go back to where they were eating before the downturn,” Sampson said. “There’s certainly the wildcard whether or not [McDonald’s] can keep the market share they have gained in coffee.”

The McCafé is one of McDonald’s riskier prospects, Sampson said, because it is new and expensive to implement. Setting up a McCafé costs about $100,000 per franchise, Sampson said.

Rollouts like the McCafé, being billed as the company’s biggest product launch in 30 years, can backfire. The McRib, for example, provides a cautionary tale. After being added to McDonald’s menu nationally in 1981, it was removed after several years due to low sales and has since been relegated to a promotional offering.

Still, many investors like to see McDonald’s pushing new products.

“Innovating in any industry is always a positive,” said Jay Berkey, vice president and senior investment officer for Maryland-based Sandy Spring Bancorp Inc., which owns more than 16,000 shares. “As long as it doesn’t cannibalize what they’re already doing, it’s a plus.”

Another possible threat to McDonald’s is its performance overseas, where exchange-rate fluctuations trimmed the company’s bottom line by 8 cents per diluted share in the first quarter.

“Obviously, they have some pretty strong currency headwinds in their international market,” Sampson said. “Clearly that’s a negative.”

Contingencies notwithstanding, analysts and shareholders said McDonald’s is poised to continue dominating the fast-food sector for the near future, which bodes well for meeting the consensus 52-week price target.

“We really don’t see a whole lot that can happen to these guys,” Hottovy said. “It really would take a seismic event.”

McDonald’s couldn’t be reached for comment.

View original, including flash graphic, HERE