McDonald's Thrives as Consumers Get Cheap

When the going gets tough, people get cheap. McDonald's ( MCD), home of the dollar menu, has benefited more than any other fast-food restaurant from the faltering economy.

The company reported impressive October results, overcoming concern that a stronger dollar would hurt international business. Global same-store sales rose 5.5%, and U.S. and Europe sales increased 5.3% and 9.8%, respectively. A revamped menu and attractive prices outweighed health concerns as consumers had less money in their pockets.

Since the health-food craze began in the 1990s, McDonald's has faced criticism for its unhealthy menu, culminating in the documentary movie "Super Size Me" in 2004. However, the restaurant remains a safe haven during turbulent times because of its convenience and affordability. The stock may extend its five-year advance if the economy continues to recede.

During an economic downturn, consumers cut costs, and McDonald's benefits from that. Many people will continue to eat out during a recession, but they are likely to trade down to cheaper restaurants. McDonald's also is a substitute for home cooking, as consumers avoid high supermarket prices in favor of the dollar menu for a cheap and effortless meal.

McDonald's recently received publicity for its standout performance in the restaurant industry, but its stock remains undervalued based on peer valuation. MCD trades at a discount based on price-to-earnings and price-to-book. More importantly, the stock has an earnings growth rate of 169.38, which dwarfs the industry average of 64.66. It carries a "buy" rating from TheStreet.com Ratings.

McDonald's revenue rose 6.2% to $6.26 billion in the third quarter. Net income increased 11.2% to $1.19 billion. Burger King ( BKC) said revenue advanced 12% in the three months through October, though earnings missed estimates due to volatile commodity costs.

Burger King is about a third of the size of McDonald's based on total restaurants, and it trails in the number of international outlets. BKC's stock is down about 30% this year. Yum! Brands ( YUM), owner of KFC and Taco Bell, has seen its shares plunge 32%. MCD has fallen just 4%.

However, numerous risks face the company.

Since McDonald's does a significant amount of international business, it faces foreign-exchange risks and may be hurt if the dollar continues to appreciate. A quick ratio of 0.82 and current ratio of 0.98 indicate a weak liquidity position. The company has a reasonable amount of debt as reflected by a debt to capital ratio of 0.43.

McDonald's business may continue to thrive if the economy shrinks further, but will that translate to stock price appreciation? Not necessarily. Even sound companies are being battered in the stock-market selloff. McDonald's has outperformed competitors and improved profitability, but the shares remain depressed. Market pessimism, not company performance, is preventing investors from reaping the rewards of McDonald's success.

Employees of TheStreet.com Ratings with access to pre-publication ratings data must pre-clear any potential trade through the legal department and are prohibited from trading any security that is the subject of an unpublished rating revision until the second business day after the rating is published. While employees cannot provide investment advice or recommendations, the writer appreciates your feedback and can be reached at jake.lynch@thestreet.com.

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