McDonald’s – A Defensive Stock Goes On Offense

McDonald’s  (MCD) continues to impress everyone with their same-store sales figures, and the stock continues to hit multi-year highs.  Worldwide comps were up 8.2% in March, highlighted by European sales up 11.2%, Asia-Pacific regions at 8.9%, and U.S. sales up 6.2%.  The company also announced a near 10% bump in net earnings estimates for the 1^st quarter, to $0.62 per share.  If McDonald’s does hit that EPS number, it would represent 26% earnings growth year-over-year. 

Any notes pertaining to MCD being “just a defensive play” or “just a value stock” had best be written in pencil.  26% earnings growth would be tremendous in a quarter where total growth in the S&P 500 is estimated to be in the single digits.  Already one of the best cash flow stories out there, McDonald’s should be getting even better as it executes on its strategy of transitioning more of the company-owned stores (about 20% of their total) into franchisee owned locations. 

Ah yes, and then there is the coffee, which almost acts like a free call option on the stock.  Their push into gourmet coffee products is going to be big, sincere, and thorough.  They get massive leverage throughout their supply chain, so we can expect McDonald’s to trounce Starbucks (SBUX) on pricing.

How much market share could McDonald’s take from Starbucks after one year, if we assume that McDonald’s eventually does a nationwide rollout?  That’s going to be a key question for investors in both companies going forward.  Starbucks’ dreams of 10,000 new stores in the next four years could be in serious jeopardy if they notice the ROI on new stores dropping by a third, or even a quarter. 

For their part, McDonald’s doesn’t have to do much to make a strong impact on the bottom line, as they have a full menu to offer any customer that walks through the door.  Coffee product margins will serve to raise overall operating margins, and could lead to change many people’s perceptions of the long-term multiple MCD stock can achieve. 

We used very conservative multiples in our break-up value analysis of MCD stock, which could be up for a re-visit.  Even at the 52-week high of $47.24, there could still be upside to the stock from here. 

MCD is set to release earnings on April 20^th before the open.  We shouldn’t expect much deviation in the actual EPS based on what the company is saying today, but the positive numbers from today could free up the stock to move higher in the coming weeks. 

Ryan Barnes

April 13, 2007

Ryan Barnes can be reached at [email protected]; he does not own securities in the companies he covers.