Novice Investing - McDonalds, We Are Not Loving It

Date: Tuesday 13th 2008f May 2008 07:33:43 AM

McDonalds, We Are Not Loving It - 01/05/2008

By: Hari Wibowo

For those of you who are not into fast food, McDonald's Corporation (MCD) is the biggest fast food restaurants in the world. It operated 31,045 restaurants in 118 countries. Contrast that with Starbucks (SBUX) which 'only' have 8505 retail stores. Further, we are not talking about 100 square meters coffee shops here. McDonald's average size for each restaurant can be two to three times bigger than average Starbucks. Thus, you can no doubt estimate the size of McDonalds.

Recently, as concern of a 2008 economic recession had surfaced, retailers had been pummeled but Mc. Donald's has stood firm with 10% striking distance of its all time high. Meanwhile McDonald's stock has actually risen 5 folds from the low of $ 12 per share reached in early 2003. At the time, concern of mad cow disease, health concern on McDonald's junk food offering has led to declining same store sales. After introducing a healthier salad menu and store revamping, same store sales at McDonald's has improved and bring significant return for shareholders. Share price has risen 400% before easing down slightly as of late. Name us a big cap company with a return of 400% over the past five years and you won't find plenty of names.

Having said that, at current condition we feel that McDonald's is not a good buy at this present price. Our main concern is its share price in relation to its fair value. If McDonalds is trading above its fair value then it is not a good investment to buy right now. Being the biggest, McDonalds of course deserves some premium over its smaller rivals. But still, McDonalds looks undervalued under that metric. After subtracting debt and adding cash, we will assume a fair P/E value of 15 for McDonalds (which implies a 6.66% yield), a fair P/E value of 14 for competitors 25-75% of McDonalds size and a fair P/E value of 12 for competitors 0-25% of McDonalds size. Size here is defined by its market capitalization. Let's take a look at various restaurant chains and its projected fair value on the below table.

Company	Market Cap.	EPS			Fair Value	Recent Price	Potential Appreciation
		2008	Growth	Present Value
Mc. Donalds	$ 67.5 Billion	$ 3.17	9.08%	$ 4.02	$ 55.80	$ 57.05	(-2.19%)
Yum! Brands	$ 18.73 Billion	$ 1.86	12%	$ 2.69	$ 34.36	$ 36.82	(-6.68%)
Chipotle	$ 4.18 Billion	$ 2.72	26.63%	$ 7.28	$ 91.92	$ 127.01	(-27.6%)
Darden Resto	$ 3.63 Billion	$ 2.68	11.63%	$ 3.82	$ 42.59	$ 25.59	+ 66.4%
Burger King	$ 3.42 Billion	$ 1.29	15.6%	$ 2.19	$ 21.63	$ 25.30	(-14.5%)
Wendy	$ 2.04 Billion	$ 1.45	12.25%	$ 2.12	$ 24.31	$ 23.34	+ 4.15%
Jack in the Box	$ 1.39 Billion	$ 2.05	12.54%	$ 3.04	$ 29.71	$ 23.25	+ 27.8%

McDonalds is not the priciest of the bunch. Chipotle grill holds that title among the sector. Generally, most of the eatery sectors are trading below fair value. With the risk of recession in 2008, we feel that growth rate will be cut further albeit temporarily. This will in turn bring down the fair value for these stocks. Most of these stocks has had a terrific multi year run. Therefore, it is best if you can avoid them now while waiting for any sign of economic improvement.

END

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Disclaimer: The sole purpose of this article is educational. This article is merely the opinion of the writer and is not in any way a buy/sell recommendation regarding Mc. Donalds Corp. (MCD) or any other securities.

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