McDonald’s Corporation (MCD): A Time For Caution

ronaldmcdonaldShah Gilani: I love McDonald’s burgers, fries, and shakes. What I don’t love is its current stock price.

Don’t get me wrong, the stock’s been a huge gainer over the past decade. It’s risen more than 230% in the past ten years while throwing off decent dividend income.

But what’s hard to digest, with the stock 5% from its all-time highs, is where it goes next.

If you own McDonald’s Corporation (NYSE:MCD) or are thinking about buying it, here’s what I suggest: tread carefully and put in a few simple hedges – like put options. There’s definitely upside here, but investors have to protect themselves. And I’ll tell you how.

Getting the Recipe Right

The first thing I look at when I’m analyzing a food company is the food. Like I said, I love McDonald’s, at least the same few items I always get. As far as their other menu items, there may be too many.

Although it’s nice to have a lot of options, McDonald’s is a fast food joint, so I don’t want to be overwhelmed by too many menu items.

In fact, analysts say McDonald’s has too many menu items. In order to be more things to more people the company has been adding more and more items for years. But the Wall Street pro consensus is they’ve diluted their core higher-margin brand items with too many cheaper options.

When the company added “Dollar Menu” items, most of their regular patrons opted for the cheaper offerings and haven’t ventured back to higher-margin menu items.

That plan backfired because while they originally planned on a limited Dollar Menu run to get back cost-conscious diners, business fell off every time the company tried to phase out Dollar Menu offerings.

Now company big-wigs are talking about changing the menu again.

The last two menu changes didn’t help the company’s slipping sales. So an investor in the stock has to wonder if company management has a clue what to offer their customers.

They might go more “wholesome,” more “organic,” more “socially and calorie conscious,” or more “made-to-order.” The problem with those changes is, while they may make sense on paper, they’ll put Mickey D’s into more direct competition with a host of casual-dining and hot-trendy competitors.

That’s likely to turn off more traditional customers before it brings in enough new customers to give new items a try, especially if more “organically sourced” ingredients end up costing customers more. As far as revenues, that’s a slippery slope.

The Advantage of More Global Franchises

What McDonald’s has going for it is it’s in 119 countries. Its 36,290 stores dwarf any competitor.

McDonald’s has announced one strategic change that should benefit investors: it’s going to add more franchise stores and cut back on company-owned stores. That’s good news for the stock in the longer-run because company-owned stores have a much lower profit margin than franchised stores.

Although no actual timeframe was given by the company, the company plans to reduce company-owned stores to only 10% of all stores over the next couple of years. That would be a reduction of about 2,400 stores out of the 6,734 the company now owns outright.

One big reason the company is cutting back on 100%-owned stores is because franchisees put in a lot of capital and pay for equipment and leases, which doesn’t impact net profits, but results in higher margins for all those restaurants.

Another big problem with company-owned stores is they too often dictate terms across the whole business. The company’s recent big public relations gambit to increase wages for McDonald’s workers wasn’t company-wide. It was only mandated at company-owned stores. Franchisees are livid. The company is now facing a huge battle with the vast majority of its store owner-operators, who aren’t employees, but effectively partners.

S&P, Moody’s, and Fitch have all recently downgraded McDonald’s debt, which is fairly substantial at $14.29 billion.

One way to better capitalize the debt load, which is mostly real estate acquisition related, is for the company to spin off its real estate holdings into a real estate investment trust. Some activists say that’s a good idea and would greatly improve McDonald’s true value. The company hasn’t embraced any talk on the subject.

A Time for Caution

While McDonald’s stock has been a stellar performer over time, I’m not sure it’s worth an investment at this juncture.

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