Fast Food Restaurants

McDonald's Corporation

When forced to choose from among a group of great companies, it's not an easy task to select the most attractive. The economics of Papa John's, the resurgence of Wendy's, and the niche stronghold of Sonic all make for attractive companies. However, McDonald's <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: MCD)") else Response.Write("(NYSE: MCD)") end if %> seems to pose the most interesting investing possibility right now. It's amazing that the company could have wasted nearly $100 million in marketing expenses alone in the last year (net of the market research and institutional lessons learned) on the Arch Deluxe and still generate close to $2.5 billion in gross cash flow. The company's absolutely dominant mind share puts it in a unique position to restart earnings and free cash flow growth if it hits upon the right marketing strategy. Given the company's ability to execute in this area time and time again, it would be foolish to bet against them.

McDonald's also operates in international markets where there is far less competition than in the U.S. In the short-term, that may mean higher margins in restaurants abroad, but that's not the most important factor in the company's international strategy. More importantly, it means that the company has a head start on foreign and American competition in building mind share in developing nations. Long term, that means cash flow growth, a continuation of the attractive economics of the company, and a steady increase in shareholder value.

Starting from a reasonable valuation of 21 times trailing earnings and about 14 times operating earnings and gross cash flow, there appears to be little downside risk in terms of those multiples. Considering the ability of the management, the economic model of the company, the market share and mind share of McDonald's, and the valuation, we believe that it has a very good chance of outperforming the market over the long term.

Latest Financials

Through six months of 1997, McDonald's has generated 7.4% growth in revenues for company-owned restaurants and 6.1% growth in high-margin franchise revenues. Six months EPS of $1.11 rose almost 10% year-over-year and trailing 12 months EPS stands at $2.32. The company has also bought back almost half a billion dollars in stock, which it has financed through debt issuance. Happily, the company is back on the road to generating free cash flow after a dismal 1996 in that department. Through June 1997, McDonald's has generated $212.4 million in free cash flow.

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