Update McDonald's (MCD) in Jubak's Picks

11/14/2012 10:30 am EST


Jim Jubak

Founder and Editor, JubakPicks.com

Wait until next year.

I think that’s the message in McDonald’s (MCD) disappointing November 8 report of same store sales numbers. Sales at stores open for at least 13 months fell 1.8% in October. That was the first monthly decline in same store sales in 9 years for McDonald’s. Even taking into account a calendar shift that put one less Saturday in October this year than in 2012, the drop sent a significant signal: competitors have upped their game; a soft economy in the United States, China, and Europe has resulted in cutthroat competition on price; and McDonald’s recent success in taking market share has resulted in very tough month to month growth comparisons for McDonald’s.

These three factors suggest that investors will have to wait until April or May of 2013 to see a sustained upwards move in McDonald’s shares. (McDonald’s is a member of my Jubak’s Picks portfolio http://jubakpicks.com//)

Economic growth will—probably—pick up in China and the United States in the first half of 2013. McDonald’s is putting in place new menu items and sales initiatives that will, over time, blunt the current momentum of Burger King (BKW), Taco Bell (owned by YUM! Brands (YUM)) and Wendy’s (WEN). And the toughest same store sales growth comparisons will be behind the company by April 2013.

I think the stock is likely to be a market performer until then—with its fortunes tied to the trends in the larger market. But the stock does pay a 3.6% dividend and after the decline to $84.76 at the November 13 close from $94.09 on October 16, I think most of the bad news about same store sales growth is now priced into the shares.

Your decision to hold on until April—collecting that 3.6% dividend—or to sell now with the idea of re-buying in the early spring depends on how good a trader you think you are, how aggressive your strategy is, and what alternative ideas you might have for putting cash to work right now.

Make no mistake about it, though; these are tough times in the quick service restaurant sector—even for a company with McDonald’s resources. Everybody has introduced and is heavily promoting a value menu. Everybody is rolling out new products—Son of Baconator at Wendy’s, Doritos Locos Tacos at Taco Bell, Cinnabon Minibon Rolls at Burger King. Some new products unabashedly follow McDonald’s lead—smoothies at Burger King, for example.

Fast food is now played like a giant game of leapfrog. One company jumps over the other by finding a particularly successful way to tweak its value menu or introducing a particularly successful sandwich and temporarily that draws sales across the playing field.

What has separated McDonald’s from the competition in recent years, though, isn’t the temporary ebb and flow of sales from menu and product innovation, but the ability to produce a steady stream of those innovations that competitors haven’t been able to match. Couple that with McDonald’s huge edge in financial muscle that lets the company refresh restaurants more rapidly than competitors and to install new cooking and order-taking systems that speed up food preparation and lower customer wait times and you’re got a formula for long-term success. In general you should only sell McDonald’s shares if 1) you think the normal ebb and flow in the company’s sector is headed into a temporary flow away from McDonald’s so that you’ll be able to take profits now and buy back in at a lower price later, or 2) if you see evidence that the McDonald’s system is showing a decline in innovation and a loss of focus on pressing home its competitive advantages.

I don’t see evidence of that second problem now.

And the stock’s 10% drop from October 16 has narrowed your window for selling and then rebuying. The stock has solid support from $80 to $85. Below that the next support shows up at around $72, about 14% lower than today’s price. I don’t look to see McDonald’s back at that level from the first half of 2011 unless the overall U.S. economy and stock market takes a dive. (And if I did I would certainly be a buyer.) And even then the stock’s 3.6% dividend should make the shares a relatively stable performer unless the overall market sells off heavily.

I calculate a target price of $104 a share by October 2013.

Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund http://jubakfund.com/ , may or may not now own positions in any stock mentioned in this post. The fund did not own shares of McDonald’s as of the end of September. For a full list of the stocks in the fund as of the end of September see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/

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