By Bill Barker (TMF Max)

Let me start by saying that McDonald's does not lend itself to my usual snide attacks from the bear side regarding my thoughts on the business. Much to the chagrin of my wife and all responsible health care professionals, I partake of the McDonald's menu on an all too frequent basis. Therefore, I think I understand the strengths and weaknesses of this business, and when you talk about the value of McDonald's, the three things that you need to keep in mind are, in order of importance: location, location, and location.

There's a McDonald's location just a block and a half from Fool Global HQ here in blisteringly hot Alexandria, Virginia. That McDonald's sees a lot of traffic not just from me and numerous other workaday Fools, but it's usually pretty crowded in general. It's in a great location to do business.

Actually, when you're talking about the domestic side of the operation, McDonald's is pretty much already in all or most of the great locations that it is ever going to have. Having been building aggressively since the 1950s, most of the good spots are long gone. Though McDonald's still has a bit of growth left in it, that growth is coming through building new establishments at more and more marginal spots.

Did somebody say McMargins? For some proof that McDonald's is generating sales growth by pursuing less and less attractive new spots, take a look at McDonald's gross margins over the last six years:

1994    40.0%
1995    39.2%
1996    38.1%
1997    37.3%
1998    36.6%
1999    36.3%

Margins for the first quarter of 2000 were down even more, continuing the disturbing trend. Speaking of bad trends, did I mention that McDonald's has basically doubled its debt load over the same time period? Today, McDonald's carries $5.6 billion in debt on the balance sheet, as compared to $2.9 billion in 1994.

So McDonald's has been borrowing money and finding its sales less and less profitable as time goes by. But so what, you say. The top-line growth is still there, and it's top-line and bottom line growth that the market really cares about. Maybe so, but, here again the trend is not at all promising.

According to our financials data page for McDonald's, the one-year sales growth comes in at 6.75%, the three-year trend is 7.46% and the five-year growth is 9.77%. The growth rate is slowing rapidly, again showing that whatever management has been trying of late is not working as well as it used to. Growth opportunities are running out, and in that case, I think I'd rather not have management in the process of doubling down on the debt column.

Let's return to the theme of location, location, location. At first blush those that are familiar with the Rule Maker portfolio philosophy might think that McDonald's is sort of a Rule Maker. After all, it certainly has the leading brand name in fast food, and it has a couple of other qualities that lend it a little Rule Maker color. However, the thing that McDonald's doesn't seem to have is "an even better direction than its present location." The location for McDonald's is just fine -- but the direction for the company just doesn't look all that promising.

If you're satisfied with the current location of the company, consider just what McDonald's has attempted in trying to branch out beyond the image that its ubiquitous clown represents. McDonald's has a secure location in the collective consciousness for satisfying kids. That McDonald's is and will continue to be a success on the kid-o-meter scale is pretty tough to argue. However that's just not enough, because barring some new genomics breakthroughs, it appears that nobody remains a child forever, and recapturing mature taste buds has never been McDonald's strong suit. (Obviously my own taste buds can under no conditions be referred to as "mature.")

Think about the McDLT and Arch Deluxe fiascoes. How many millions were spent on those advertising campaigns and how flat did they fall? Even worse, consider that McDonald's next attempt at securing a large percentage of the more mature palate is apparently to buy up Boston Market. Yikes.

I look at the near horizon and I see the minimum wage about to be notched up yet again and I see a tight labor market forcing McDonald's to raise wages across the board for employees above the entry level. Furthermore, weakness with the Euro has KO'ed the earnings picture for this year, and the company just warned analysts to drop their EPS figures by five cents. That means that McDonald's will probably have earnings about 10% higher this year than last -- at best. That isn't a terrible accomplishment considering the size of the company, but it isn't terribly impressive either.

So, given all this, where can you find McDonald's stock? Despite the fact that margins are on the decline and sales growth has stalled, the price of McDonald's stock nevertheless finds itself at a price/sales and price/cash flow multiple that is about 50% higher than its historical average. That's yet another location that just doesn't look very good to me.

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