Change moves stock prices. Let’s look at McDonald’s. The shares dropped precipitously from a high of $48 in November 1999 to a low of $12 in March 2003. In January 2003 Jim Cantalupo, a former McDonald’s president, came out of retirement to take over as CEO. He stopped the slide in profitability that began in 2001 and positioned the company for significantly higher returns. Mr. Cantalupo’s return to the company was the inflection point of major positive change at McDonald’s. Sales and profitability have been expanding since.
Reflecting McDonald’s turnaround, the shares currently are trading at $32. I put McDonald’s through the scrutiny of the Company Stock Risk Profile’s™ 50 category analysis. The shares came out with a Medium Risk Profile rating. This doesn’t seem intriguing at first glance, but let’s look behind the rating:
- The company failed 5 out of 7 categories under profitability, namely producing profit ratios below historical performance and relative to the industry and S&P 500. But McDonald’s has been in a turnaround mode, and what’s important here is the positive change occurring in margins and return on equity. Furthermore, since the current level of profitability is considerably lower than what McDonald’s has been able to achieve in the past, there still is room for improvement.
- I would prefer a much lower long-term debt to total capital ratio than 40.1%. However, McDonald’s generated $2.7 billion in free cash flow in the latest 12-months through last year’s third quarter, up from $2 billion in 2003. Cash on the balance sheet grew to $1.6 billion at the end of the third quarter, up substantially from $493 million at year-end 2003. Reflecting management’s confidence in the business and continuing strong cash flow, the company boosted the annual dividend 38% to $0.55 per share last September, and this was on top of a 67% increase in 2003.
- I like to see no more than 50% of the analysts covering a stock recommending buy. While the percentage for McDonald’s is 57%, there still is plenty of room for upgrades. An upgrade to buy just came through the other day. Although gradual, earnings estimates have been moving higher also.
- McDonald’s failed only 3 out of 12 valuation categories. The company’s improving fundamentals have yet to be fully reflected in the share price.
It is not often that an industry leader with a solid franchise falls into the rubble pile as McDonald’s did a few of years ago. Those investors who found the stock there were richly rewarded. McDonald’s turnaround is now well on its way. While the easy money has been made, the shares continue to offer good value.
