Big, franchised restaurant chains that sell high volumes at low cost aren’t going to be a good bet at the moment. That’s why I’m tipping this particular company as a ‘sell’; the costs of raw materials are rising but consumers don’t want to pay more, especially as disposable incomes are being eroded by price rises in virtually every other sphere of life. Margins and profits are likely to be hit so it makes sense to get out now.
McDonald’s (NYSE: MCD) rated a BUY by Deutsche Bank
McDonald’s, the world’s largest restaurant chain and synonymous with “Golden Arches, Big Mac, Quarter Pounder and French Fries”, has been moving away from its trademark meals of burgers and fries washed down with a bucket of coke. Instead, it has begun promoting healthier menus, such as “premium chicken wraps”, and offering speciality coffees from its McCafe range. Even the decor has received a makeover, with the overt “plastic red and yellow” livery being tempered by more subtle woods and neutral colours.
This re-positioning started a few years ago and the good news for investors is that the firm is now selling around 540 million snack wraps a year and has doubled its share price over the past three years.
But I think it’s time get out. Why? Firstly, because McDonald’s is predominantly a franchised business with two-thirds of its restaurants operated by third parties. This arrangement works when times are good, but not when it’s difficult for outsiders to raise capital to open new stores – which is how things stand now.
Second, McDonald’s raw material costs have gone through the roof just when consumers aren’t prepared to accept higher prices. This is likely to mean its margins and profits will take a hit. And lastly the stock looks too expensive. Wall Street forecasts put the shares on a current p/e of 17.2 and a 2009 p/e 15.8. With disposable incomes shrinking and unhealthy diets under attack, that’s too expensive: I reckon that like Starbucks and Krispy Kreme Doughnuts, McDonald’s will soon be suffering from indigestion.
Recommendation: TAKE PROFITS at $57.80 Market capitalisation $65.5bn
• Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments