McDonald’s Moves Could SuperSize Stock

06/21/2007 12:00 am EST

Focus:

Jon Markman

Editor, Trader's Advantage

Jon Markman, editor of Jon Markman’s Strategic Advantage, says the fast food giant’s efforts to remake itself and reach out to broader audiences will continue to pay off big.

McDonald’s (NYSE: MCD) sure knows a thing or two about being big. More than 100 billion people have been served under its Golden Arches [in] 31,000 restaurants in more than 120 countries.

To keep its grills sizzling in all these restaurants, the company also runs a gigantic marketing budget of $2 billion, which [means] there’s a whole lot of “I’m Lovin’ It” on the airwaves. This has been driving McDonald’s efforts to rebrand itself [away] from its Super Size Me reputation.

These initiatives have been focused on enticing adults into visiting this restaurant chain that is already loved by the younger generation. The company is preparing a big push in its beverage business [which] will mimic that of its high-end chicken offerings. There, the company started by changing its venerable McNuggets to an all-white-meat recipe. This opened the floodgates to follow-up offerings including its Chicken Select strips and Premium Chicken Sandwiches as the market accepted its flight of fancy in poultry.

Following the success of this strategy, the vanguard for the beverage line was the decision to start offering cups of Seattle’s Best Coffee—a division of Starbucks (NYSE: SBUX)—at its locations. Now, plans call for a continued push into coffee-based drinks as well as fruit smoothies. Also, look for a shift towards bottled “alternative” beverages such as teas, flavored waters, energy drinks and juices.

[Meanwhile,] the company isn't forgetting about the children who already love McDonald's Happy Meals and Playlands. McDonald’s is concentrating on making its children’s menu more acceptable to health-conscious parents.

The super-sized marketing budget will help point out new choices for Happy Meals, such as milk in lieu of soda and apples instead of fries. Nonetheless, 20% of the $2 billion marketing budget will be spent on ads touting active lifestyles, children’s health, and the higher quality of McDonald’s meal offerings.

I believe these efforts will gain traction, as the sheer number of McDonald’s locations—with their corresponding convenience—will instill a powerful urge to try out these new menu items.

Marketing magic aside, McDonald’s also generates tons of cash, and it had a 5% free cash flow yield in 2006, which is expected to increase to 8% this year. Very conservatively, I expect the company will repurchase $1 billion worth of its own shares over the next year.

Earnings per share growth is likely to remain in the high single-digits over the near term, which gets me to a 2009 EPS estimate of $3.22. As its return on invested capital has been improving lately, McDonald’s should see its price/earnings multiple move towards the higher reaches of its five-year range, near 20x. Buy MCD for my 16-month target of $64—a nice, juicy 23% move from [Wednesday’s closing price above $51—Editor].  

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