1 Reason This Top Dow Stock Will Keep Winning
McDonald's (NYS: MCD) has been on a tear in recent years. Under the leadership of rock star CEO Jim Skinner, the company has:
- Quadrupled its share price.
- Outperformed every other company on the Dow Jones Industrial Average (INDEX: ^DJI) .
- Almost doubled free cash flow.
- Increased same-store sales for 106 consecutive months.
Keep in mind that McDonald's was already the world's largest restaurant chain when Skinner took the helm, so it's not as if he had a hip new restaurant he needed to pitch. Instead, he just made McDonald's better in every way.
But with all this success, and the recent news that Skinner will step down as CEO in June, many investors are wondering whether McDonald's can keep up this impressive run.
The answer is yes.
First, the management changes: Skinner helped draft and execute the wildly successful "Plan to Win" strategy at McDonald's. Now that he's leaving, many are left wondering whether his replacement, Don Thompson, has the same vision. Fortunately for investors, he has made it explicitly clear that he does intend to stick to the strategy. In fact, the company will spend $2.9 billion to remodel 2,400 existing locations and open 1,300 new ones this year.
It's also important to note that Thompson was the man behind the rollout of the margin-accretive and market share-stealing McCafe beverage line, which has helped McDonald's grow operating margins to an industry-leading 32%, up from just 17% in 2007. McCafe has even been cited as a legitimate competitor to the offerings at coffee mecca Starbucks (NAS: SBUX) . The recent expansion of Starbucks' juice-bar concept should serve as affirmation of the value of McCafe's non-coffee offerings as well.
Cheap food isn't cheap
Critics claim McDonald's has run past itself. With a P/E of 18, The company has traded in the high range of an 18 P/E the past few years, which is higher than the Dow's current 15 P/E, but this is also exactly where the company sat when Skinner became CEO and began his Dow-stomping performance. And at 2.9%, McDonald's dividend is also half a percent higher than the Dow average.
What you get
But that small premium awards you three things most other stocks on the Dow don't have (at least not all together).
- A brand ranked the sixth-strongest in the world.
- Enormous growth potential.
- Annuity-like income.
Interbrand's 2011 ranking places McDonald's near the top of its list for global brand strength, which will be crucial fuel for the second point -- enormous growth potential. The company is following Yum! Brands' (NYS: YUM) lead and making a big bet on China. With 250 planned openings there this year, and as many as one new opening every day by 2013, the company could hit 2,000 outlets in the country in just two years.
That sounds like a lot, but it's just the tip of the iceberg. With a population 4.3 times that of the U.S., China has a lot of mouths to feed, and McDonald's is under-penetrated there. On its home turf, the Golden Arches has one location for 22,000 people. If it can achieve even a fifth of that penetration in China, its store count would grow almost ninefold from where it is today, and that assumes the population doesn't grow. And we're talking about a market that bumps up on Europe and the United States in terms of sales and profitability.
While McDonald's currently has about a third as many locations as Yum! in China, it's the U.S. base that will keep Ronald crushing the Colonel with a stream of consistent revenue. In addition to hefty royalty payments, McDonald's owns the real estate at 45% of its restaurants, so it gets to tack on a nice, steady stream of rental revenue as well. This income is consistent and doesn't fluctuate with weak sales, either. So while rampant expansion is expensive, McDonald's has the dry powder to make it happen.
That's not to say the U.S. is fully matured yet, either. Despite huge penetration, U.S. same-store sales growth in January was 7.8%, followed closely by a 7.3% gain in its Asia/Pacific and Middle East and Africa regions. In February, there was an even more impressive 11.1% gain in the U.S. and a still-growing 2.4% in its APMEA segment.
The naysayers about McDonald's future growth potential fail to realize exactly how large the runway is for this giant. It has an incredible model with a strong brand that allows it to pour money back into expansion, dividends, share buybacks, and renovations. The company's potential for growth in China is mind-boggling, and it's only just in its infancy there. The new CEO shuffle shouldn't give investors reason to pause, either.
These are just a few of the reasons McDonald's has not only been called The Greatest Dividend Stock on the Dow but has also been highlighted as one of the 3 American Companies Set to Dominate the World. You can learn about the other two right here.
I don't think McDonald's run as a top Dow stock is over, and I believe that over the long run it'll continue to outperform its peers on the index.
At the time this article was published Austin Smith owns shares of McDonald's. The Motley Fool owns shares of Starbucks.Motley Fool newsletter serviceshave recommended buying shares of Starbucks, McDonald's, and Yum! Brands and writing covered calls on Starbucks. We Fools don't all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. Try any of our Foolish newsletter servicesfree for 30 days. The Motley Fool has adisclosure policy.
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