McDonald's (MCD) Continues to Dominate ~ market folly

Thursday, September 11, 2008

McDonald's (MCD) Continues to Dominate

As I mentioned in my post about a deteriorating consumer environment here, I think McDonald's is shaping up to be an excellent play. Earlier in the year, McDonald's (MCD) was touted as a "weak dollar" play due to their extensive international exposure and the massive currency gains they were posting from the exchange rates worldwide. But, things have changed in six months time. Nowadays, a recently strengthening dollar provides currency headwinds for MCD's global business. But, I do not see this as being a major problem because demand and sales should easily overshadow any and all currency implications.

Why might you ask? The answer is simple: consumers worldwide trading down to "cheap" alternatives. McDonald's is the king of cheap. They are a fast-food chain, after all; with a $1 menu to boot. When consumers are in a pinch, they look to save money anyway they can. And, McDonald's allows them to do just that. As I wrote about here, the US economy is accelerating to the downside. Then, add in the fact that Goldman Sachs thinks half the globe is in a recession. Lastly, you've got the former federal reserve chairman Paul Volcker claiming that growth in the US economy will be the slowest of any decade since the Great Depression, as I noted here. Tough times ahead to say the least. The US consumer is in for a wild ride. So, if you're going to play any consumer stock in such a tough environment, make sure it is a company that deals with necessities. McDonald's provides food, and cheap food at that. Don't buy the rationale? Just take a look at McDonald's most recent quarter.

McDonald's delivered yet another dominant quarter last Tuesday. August sales in the U.S. increased 4.5% compared to an analyst expected 3.5% gain. Sales in the Asian Pacific region gained 10% and an 11.6% gain in Europe compared to analyst expectations of only 6% in Europe. On average, analysts pegged McDonald's at a global increase of 4.7%. McDonald's came in with a 8.5% gain globally. Needless to say, it was a dominant quarter. They are winning cash-strapped consumers over in both the US and Europe. And, their market position in Asia continues to be very profitable. Not to mention, MCD is seeing operating margins of 25.78% and a return on equity of 29.71%, both solid numbers which reflect the strong underlying fundamentals.

People were concerned that economic weakness in Europe would hurt sales. But, I argue the opposite. A weak Economic environment means more people trade down to cheaper alternatives. European consumer confidence is at one of the lowest levels in five years. Their economy is contracting as their consumers face the exact same problems ours do: rising food and fuel prices. In the US, the cost of living rose 5.6% for the year (ended in July). The U.S. Labor Department reports it is the largest jump in 17 years. So, as the cost of living goes up, consumers look to trade down. It's that simple.

And, if you're worried about consumers "shutting down" altogether, then look to go long MCD and hedge your position by buying some puts or by shorting rival discretionary casual dining restaurants such as BJRI or DRI. Those casual dining chains are suffering from rising input costs and slower dining traffic. At any rate, I think MCD is a solid choice going forward. Let's see how it sets up on the technicals. Pulling up a 3 year chart on MCD, we see that it is in a nice long-term uptrend. Every major dip in the name has been a buying opportunity, as you can see below.

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Then, zooming in on a closer 6 month time frame, we can see how MCD has been trading recently.
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You'll notice it put in a most recent high at around $65/66 and then sold off. That level represents some near-term resistance in the name and you could see some sellers come in as MCD begins to trade back up near those levels as it is doing now. What you'll also notice is that during the months of May, June, and July, MCD was bumping up against severe overhead resistance at around $60/61. This is shown by the lower of the 2 horizontal red lines I've drawn in. You can see it kept bumping up against that resistance level before finally enough buyers came in August to push it through to new highs. After those recent highs, you will see that MCD came back down to that $60/61 level that was previously resistance. And, that level now acts as a support level to the stock as it bounced off those levels, trending back higher. So, in terms of selecting opportune entry, exit, and stop loss points, the chart gives us a pretty clear picture. How you play it is determined by whether or not you are an investor or trader. But, as outlined above, I think McDonald's (MCD) is poised to benefit in the coming months.

Disclosure: is long MCD

Sources: WSJ, Bloomberg

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