Hold the Big Mac and Fries
08/12/2010 3:01 pm EST
McDonald’s (NYSE: MCD) has put together an extraordinary 2010—so far. But I’m not as excited about the second half of the year, especially not at current share prices.
On Monday, August 9, McDonald’s announced that global comparable-store sales climbed 7% in July from July 2009. Sales at restaurants open for 13 months or more rose 5.7% in the United States and 10% in Asia, Africa, and the Middle East.
McDonald’s sales are indeed hitting on all cylinders: The dollar menu, new higher-priced menu offers, frozen frappes, and upgraded coffee drinks have all boosted sales since their rollouts.
However, it’s not sales that worry me, but margins. In the first half of 2010, McDonald’s benefited from falling commodity prices for wheat, corn syrup, sugar, beef, chicken, and other raw materials. In its last conference call with analysts, the company said that it expected commodity prices to continue to decline in the second half of the year, but at a reduced rate.
With wheat and other grain prices soaring on drought, wildfires, and grain export bans, I don’t think declining commodity prices are guaranteed in the second half of 2010.
That wouldn’t be a problem, except that the stock has become rather expensive given the 13% earnings growth projected by analysts for 2010 or the 8.2% growth rate projected for 2011. That works out to a price-to-earnings/growth (PEG) ratio on 2011 earnings growth of almost two times. (Growth-at-a reasonable-price investors look for a PEG ratio of 1 or so.)
That doesn’t leave much room for a disappointment on margins if commodity prices stay high or climb higher for the rest of 2010.
The stock is up 17% so far in 2010, compared to a 1% gain for the Standard & Poor’s 500. I’d give it a rest here and look for a better second-half stock.
As of August 12, I'm selling McDonald's with a gain of 20% (plus dividends) since I bought the shares on January 13, 2009. The stock traded below $72 Thursday afternoon.
Full disclosure: I don’t own shares of any company mentioned in this post in my personal portfolio.