McDonald's Bull's Pen
by Chris Rugaber ([email protected])

McDonald's possesses one of the most successful, recognizable brand names in the world, second perhaps to Coca-Cola in international recognition. It dominates the U.S. fast-food market, with 32.5% market share among the top ten "Quick Service Restaurants" (QSRs). In 1997, its U.S. sales of $17.1 billion were more than the next three largest hamburger-based fast-food restaurants combined.

Looking at McDonald's revenue and profit numbers is to watch an inexorable upward march: revenue, net income, and earnings per share (EPS) have all doubled, at least, in the past ten years, without a single downturn. And check out these ten-year compound annual growth rates: total revenues, 8.9%; operating income, 9.2%; net income, 11.6%; and finally, diluted earnings per share (EPS), 12.4%. The fact that EPS has grown more quickly than revenues is a sign of a well-managed corporation. Neither Asian nor U.S. recessions, botched marketing campaigns, or an image among many as the quintessential soulless corporation can stop the juggernaut.

Readers of The Motley Fool's Industry Focus '98, our annual survey of industries that the Fool thinks are well-positioned for future growth, might have noticed our take on McDonald's: "Considering the ability of the management, the... market share and mind share of McDonald's, and the valuation, we believe it has a good chance of outperforming the market over the long term." Since the Fool's Jeff Fischer typed those words late last year, the share price has jumped over 40%. (The Industry Focus was for sale earlier in the year, but is no longer available; keep your eye out for next year's edition!) His comments then about management and market share are still valid; I will discuss valuation later.

A key to McDonald's current and future growth is its international expansion. The company is a perfect example of how U.S. corporations have taken advantage of the global economy. From 1987 through 1990, McDonald's opened restaurants in just six new countries, but from 1994 through 1997, McDonald's expanded into thirty new countries, for a total of 109 by the end of the year.

And McDonald's doesn't just open a restaurant or two here or there, but everywhere. For example, how many McDonald's would you guess there are in Romania? Twenty-eight, to be exact. And how many in Andorra, one of the world's smallest countries, nestled between France and Spain in the Pyrenees? Two, actually. Furthermore, McDonald's will tailor its menus for global tastes, serving lamb in India and Teriyaki Burgers in Japan. As a result, it has earned global mind share of the kind that made it ubiquitous here in the United States. Newsweek once reported that Japanese children visiting Los Angeles would see a McDonald's and squeal, "Oh look, Mommy, they have McDonald's here too!" It may be an apocryphal story, but it speaks volumes. Clearly, these children are not growing up seeing McDonald's as a "foreign" entity. And even those countries that are not so welcoming eventually give in: there are now 629 McDonald's in France, more than double what there were six years ago.

Of course, many people may regard this as somewhat unpleasant -- I mean you can't even go to Tahiti without seeing a McDonald's -- but for investors it's nothing to gripe about. Over 60% of McDonald's sales and profits are from abroad, but despite the global presence just described, there's plenty of room to grow. There are currently 46 McDonald's for every million people in the U.S., while there are less than 3 for every million people in the countries outside the U.S. that McDonald's currently serves.

What McDonald's calls its new and emerging markets have already seen big jumps in operating profits, and the company is planning on further expansion over the next three years in Central Europe and Asia. Given its history of execution, as long as McDonald's is opening new restaurants and developing new markets, it will make money.

But what about its most developed market, here in the ol' U.S. of A.? Certainly there have been some missteps recently, such as the "Campaign 55" and the Arch Deluxe (which I actually liked). In addition, Mickey D's may have expanded too aggressively and opened too many new restaurants. Yet Campaign 55, which priced some sandwiches at 55 cents, was dropped within six weeks, and it's unlikely any customers were lost. After all, do you know anyone who refuses to eat at McDonald's because of Campaign 55? I doubt it.

Domestically, McDonald's is a giant on the landscape that retains the ability to move in a nimble fashion. The new CEO, Jack Greenberg, is introducing new products left and right -- the Big Xtra, the McFlurry -- and the company aims to have its "Made for You" food preparation system in all U.S. and Canadian restaurants by 2000. The company recently laid off workers at headquarters for the first time in its history, and is continuing to decentralize its U.S. operations. All these actions combined indicate management's ability to avoid complacency and inertia, which is key for a big, successful company like McDonald's.

Regarding valuation, as of July 17th its trailing P/E was 30 and its year-ahead P/E was about 25.8, so it's not cheap, though in this market it's not really that expensive, either. But for a company with virtually guaranteed revenue and earnings growth far into the future, do you want to act Wise and try to time your entry into this stock, or simply jump on and enjoy the ride?

Next: The Bear Argument