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Six Stocks Activists May Rock in 2006 ," the stock has held its ground, barely moving as the market has fallen significantly off its highs. The activist buzz has settled down and McDonald's has demonstrated its ability to execute on several levels. I think there is a lot of value left in this play: It could easily see $40 by year-end. Since my piece, several things have happened:
Grab a Value Meal, by James AltucherSince I wrote about McDonald's in "
- McDonald's has decided to sell 1,500 company-owned restaurants within the next three years. While this isn't the 8,000 activist investor William Ackman wanted the company to sell, it is certainly a start. I believe once management and investors realize the clear benefits of a shifted business model, the company will proceed to sell more company-owned restaurants.
- The company said it would buy back $1 billion in stock. While this isn't the $13 billion Ackman demanded, it will certainly help to increase shareholder value. Because the company is buying back roughly 30 million shares, the stock price should appreciate simply due to expansion in EPS/cash flows/EBIT/EBITDA per share. Many Wall Street analysts justify valuations by saying a stock should trade at Y times earnings per share. With fewer shares, the EPS figure inflates.
- Chipotle (CMG) has come public at a solid valuation, showing investors that McDonald's can actually deliver value. Spinning Chipotle off allowed investors to receive the premium valuation this growth business deserves. Chipotle currently trades for 35 times earnings and 22 times EV/EBITDA vs. nine times EV/EBITDA and 22 times earnings for the parent company.
Much like Denny's, McDonald's earns tremendously greater margins from its franchising business than from company-owned restaurants. As the company makes this shift, I expect it to generate significant cash from the sales and significant increases in EBIT and EBITDA margins. As a result, I expect EBIT to increase from $4.02 billion in 2005 to roughly $4.8 billion in 2007. In addition, I expect EBITDA to expand to $6.4 billion by 2007, compared to just $5.3 billion in 2005. As of now, the company trades for nine times EV/EBITDA and 18 times earnings. While it's hard to find a "correct" comparable, it seems to be fairly valued. For example, Wendy's trades for 11.5 times EV/EBITDA and 31 times earnings, and OSI Restaurant Partners and YUM! trade in line with McDonald's. While this doesn't make McDonald's look dirt cheap, I don't believe these other names have the same EBIT/EBITDA expansion potential as McDonald's due to its refocusing on the franchising business and shrinking of the company-owned restaurant business.
wrote Thursday that McDonald's has earnings momentum and could surprise to the upside. Add to that the fact that it developed another concept besides Mickey D's -- Chipotle -- and it tells us just how special this name is. I believe this could be the second-best defensive stock in the market after Pepsi ( PEP). It's well run and much better than it used to be, and that's coming from someone who hasn't always been a fan. A close above $35 would be my signal to buy. But keep something in mind -- it's expiration Friday, and there is significant open interest at the $35 strike price. So it's likely that McDonald's could get pinned at the strike and force us to wait until next week before determining whether Wednesday's advance has any legs. So here's the bottom line: The trend is always your friend, and the trend is moving higher. So McDonald's remains a buy on dips unless the stock hits $32 before it hits $36. Only then would I say that the uptrend is in trouble.