Why McDonald's still outdoes the competition

Even in a slow economy, the company has delivered value pricing and kept margins high.

By Jim J. Jubak May 23, 2012 3:54PM
Image: McDonald’s restaurant © AFP/Getty ImagesTake a tour of a your neighborhood McDonald's (MCD) and then of a Burger King and a Wendy's (WEN). I think you'll see that McDonald's has separated itself from the competition. 

Yes, it's still the place to go for a Big Mac, but the company now sells premium coffee, smoothies, and salads (and, yes, I've actually seen someone order and eat a McDonald's salad.) A good number of the McDonald's I've visited lately (research, research, research) have been refreshed (the high-tech mix-your-own-soda machine is a blast). The company has found a mix that keeps the best of the old (I saw two teenagers order Happy Meals at lunch today) while adding the new (Iced Caramel Mocha, for example.)

I think Wendy's is still a great basic burger experience. And, yes, the burgers at a specialized chain like Five Guys are better. But for variety of menu (I've never seen anyone order a hot dog at Five Guys), price, and considering in a soft global economy, I think I'd bet on McDonald's in that competition, even over middle-market purveyors like Starbucks (SBUX).

What been most impressive to me about McDonald's performance during the slow post-financial crisis economy in the United States and around the world has been the company's ability to deliver value pricing and yet keep margins high even with commodity prices climbing. 

Operating margins were 31.6% in 2011 compared to 3.9% at Wendy’s and 14.4% at Yum Brands (YUM). Standard & Poor's calculates that operating margins at company-operated restaurants were 18.9% in 2011 and will fall to 18.5% in 2012 due to higher commodity prices. But that small decline will still keep McDonald's well ahead of competitors.

Companies that are as big and dominant as McDonald's can find it hard to profitably re-invest earnings but McDonald's does have one major market to conquer, China, where the company trails Yum Brands' Pizza Hut and KFC chains. McDonald's now has 1,400 restaurants in China (compared to 4,500 for Yum Brands.) McDonald's plans to open 250 new restaurants in China in 2012, up from 200 in 2011, but that leaves the company with plenty of overhead room.

I added McDonald's to my Jubak's Picks 12-18 month portfolio on May 18 in my post. As of May 23, I'm putting a one-year target price of $109 on these shares.

I know this is a tough market in which to buy anything. But here's how I think of this buy. McDonald's currently pays a 3.1% dividend yield -- more than a 10-year Treasury and certainly more than any CD you'll find. The price of the stock will, of course, vacillate and in the short-term you could lose money on these shares. But I think the chance of a permanent impairment of capital here is very small. (That is, I don't think these shares will go down and stay down.) So I think this is a way to earn a better return than a 10-year Treasury and to eventually see an attractive capital gain.

At the time of this writing, Jim Jubak didn't own shares of any companies mentioned in this post in personal portfolios. The mutual fund he manages, Jubak Global Equity Fund (JUBAX), may or may not own positions in any stock mentioned. post. The fund did not own shares
of any stock mentioned in this post as of the end of December (although it did own shares of McDonald's Latin American franchisee Arcos Dorados.). For For a full list of the stocks in the fund as of the end of the most recent quarter, see the fund's portfolio here
May 31, 2012 10:51PM
McDonalds sells sauces and cheese not sandwiches. Take the sauce and cheese away and your left with a pretty bad sandwich. But, prices are cheap and people keep buying. Their fries are good. I look for continued success.
May 31, 2012 10:49PM
McDonalds sells sauces and cheese not sandwiches. Take the sauce and cheese away and your left with a pretty bad sandwich. But, prices are cheap and people keep buying. Their fries are good. I look for continued success.
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