Buy McDonald's Now

 | Aug 20, 2013 | 10:00 AM EDT
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We recommended McDonald's (MCD) in September 2012. While the stock is modestly higher since then, it has lagged most of our recommendations as well as the overall market.

Since our recommendation, the dividend has increased by 10% and currently stands at 3.2%. We are expecting an increase of similar magnitude in the fourth quarter of this year, which would further boost the dividend yield to 3.5%. Simultaneously, McDonald's revenue and earnings continue to grow.

The combination of growing earnings and dividends in the face of a lagging stock price has moved the stock from attractive to compellingly attractive. Moreover, in light of the market's strong gains over this period, McDonald's shares have become an even more pronounced value relative to the overall market. Finally, McDonald's should provide a good deal of stability in the event the market enters a turbulent period.

All told, we believe McDonald's is a compelling stock to own at current levels. The following updates our reasoning:

As we originally highlighted, McDonald's is still the premiere global fast-foods restaurateur with 34,000 global locations. Management intends to expand these outlets by 1% to 3% per year, mainly in the emerging markets of Asia, Latin America and Eastern Europe.

Management continues to do an excellent job running the company, by expanding menu offerings, upgrading interior decors, expanding store hours and providing customers with fast, friendly and convenient service. As a result, McDonald's market share is expanding at healthy levels, even in light of its recent setbacks.

We believe the disappointing results are due to continued macro-economic weakness, an environment beyond management's control. In particular, Europe and Asia have been growing below trend. Europe has been contracting with same store sales down 1% to 2% for the year. France and Germany have been particularly weak.

Asia has also been disappointing, with negative same store growth rates registered in both China and Japan. The U.S. market has seen a bit of a recovery, but 1.6%-plus same store growth is below long-term company averages.

Management has stepped-up its game with new product innovations, expanded media campaigns and strong buyback programs in order to boost company profits. Over time, these successful initiatives should pay off for long-term shareholders since the company is beating the competition. Again, it is the challenging macro environment that is blunting the impact of management's successful initiatives.

At a recent share price of about $95, McDonald's trades at 16.8 times 2013's EPS estimate of $5.64 and 15.6 times 2014's EPS estimate of $6.10. The shares have historically traded at 16-plus times earnings and when sentiment is more positive they trade at 18 times to 20 times earnings.

Analysts expect revenue to grow 3% to 4% per year while net income should grow by 5% to 6%. With share repurchases, earnings per share are projected to expand 7% to 8% per year. The projected dividend rise to 3.5% later this year would compare very favorably with the market's 2% dividend yield.

Bottom line, we believe McDonald's offers investors compelling value now. Its strong business franchise combined with a reasonable valuation and a healthy dividend yield should protect investors in a choppy market. Furthermore, when the macro environment eventually does turnaround, McDonald's should allow for better than average capital appreciation potential due to its modest valuation levels, state of the industry operations execution and shareholder-friendly orientation. 

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