Extended markets ran into resistance where expected this week, within the Sept. S&P 2810-2820 (S...
A Safe Harbor Stock for Now
04/22/2010 2:47 pm EST
What you want to do about McDonald’s (NYSE: MCD) in the short run—say, the next six months or so—depends on how optimistic you are about the economy and the stock markets.
The more optimistic you are, the less reason you have to hold McDonald’s. The more you believe that the stock market might stall or correct slightly over the summer, and the more you’re worried about economic growth slowing (but not stopping) in the second half, the more you’ll want to hang on to your position. (For more on why you might want to hold onto this stock for the long run, see this post.)
I fall, frankly, into the more pessimistic second camp. So, I’m going to keep these shares in Jubak’s Picks. The company’s first quarter earnings, announced on April 21, make the decision to stay on board much easier.
The story in the company’s first quarter earnings was simple: Growth in the US is back.
McDonald’s reported first quarter earnings of $1.03 a share, seven cents above Wall Street’s projections. Revenue climbed by 10.5% from the first quarter of 2009, to $5.61 billion. The Wall Street consensus looked for $5.52 billion.
Europe, with a 5.2% increase in comparable-store sales, and Asia/Pacific, Middle East, and Africa, with a 5.7% increase, once again led the company’s revenue growth. But for the first time in many quarters, comparable-store sales increased in the US as well—albeit at just a 1.5% rate.
But the trend seems to be accelerating. US comps were just about flat in January and February, but climbed 4.2% in March. And in its conference call, the company said April comps look likely to match or exceed the March numbers. Operating margins in the United States rose by 2.1 percentage points to 20.4%, on lower commodity costs, magnifying the effects on the bottom line of a return to growth in the US.
Global consolidated operating margins climbed 2.2 percentage points to 29.8%. Analysts expect that while commodity prices will climb in the second half of 2010, McDonald’s will be able to cut operating expenses elsewhere to keep margins near that level.
So, how much do you want to pay for the McDonald’s growth story? The stock now trades at roughly 14.5x forward earnings per share. That’s cheap for McDonald’s if you look at the historical comparisons: The lowest price-to-earnings ratio from 2000 to 2006 was 16.5x.
The consensus among investors, though, seems to be that McDonald’s huge size means that growth must be slowing. For example, the company will open 150 new stores in China this year, but how much effect will that have on a company that does $23 billion in annual sales?
Wall Street analysts are pegging growth at 11.6% in 2010 and 9% in 2011. They estimate five-year annual growth at 9.1%.
The extra value in that growth, though, is its predictability in all kinds of economies. McDonald’s now trades at roughly a stock market multiple. Given its rate of growth and the predictability of that growth, I think that’s a bargain.
As of April 22, 2010, I’m raising my target price to $74 a share (16.5x my forecast for 2010 earnings per share) from the current $72-per-share target and am moving up that projection to July from September. As of April 22, the shares yielded 3.2%, and were trading around $70.69.
Full disclosure: I don’t own shares of any stock mentioned in this post.
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