McDonald’s Stock: A Play on the Fast Food Shortage?

Drive down just about any commercial strip in the country, and you’re treated to a blur of garish signs – burgers, wings, pizza, tacos — each trying to lure you into the drive-through. With 311,483 outlets classified as limited service eateries by the market research firm Technomic, as of the end of 2009, if anything the country would seem to be over-supplied with fast food. And American waistlines certainly back that up.

But even fast food suffers in a recession, with fewer outlets opening and more being shut down. And comparing the total outlets to U.S. population, one gets a gruesome but meaningful ratio (mouths per deep fryer?), and sees that during the years 2007-2009 fast food outlets grew scarcer relative to the overall population. In 2007, the people at Technomic found, there were 968 mouths per outlet. Two years later, with a stagnant industry and six million new Americans, there 18 more mouths, or a total of 986, for each outlet. Less competition.

A similar and longer period of industry stagnation occurred from 2000 to 2005, and both of these periods had to be good for McDonald’s (MCD).

McDonald’s Stock Chart

McDonald’s in 2003 devoted itself to improving its existing stores – as opposed to the rather rapid growth in outlets of prior years – and found that consumers liked the cleaner restrooms, snappier service and new menu items. The stock has been a rocket. And you can see below McDonald’s leaving one-time rival Yum! Brands (YUM) in the dust.

MCD, YUM Market Cap Chart

McDonald’s just announced a quarterly dividend increase in September, to 61 cents, but even at the old payout of 55 cents the yield wasn’t too shabby.

And the company funnels billions more to holders via buybacks.

McDonald’s Stock Buyback Chart

The performance under Jim Skinner, McDonald’s CEO, has indeed been remarkable. The chain serves 60 million people a day, up 14 million since 2002. It produced growing sales in each of its global regions the past six years. Among Skinner’s goals: “differentiate our brand and truly distance ourselves from the rest of the industry.”

Perhaps all the sprucing has bullet-proofed McDonald’s against the competition. It certainly outclasses other fast food stocks, qualifying as a fabulously-run company in a crummy industry.

But competing against weaker players isn’t always easy (ask Southwest Airlines). Fast food history is full of price wars; McDonald’s doesn’t lose these wars, but profits suffer for all the players. And with bank lending soon to unfreeze, the number of new eatery outlets could start to grow again, and mouths-per-outlet could shrink. That itself could prompt price wars.

YCharts looked at McDonald’s stock last May and found it a solid investment, and it remains so. It’s a tad pricey, with a p/e ratio of nearly 18. But the company’s continuous improvement and its earnings leverage – a little bit of revenue growth produces more than a little profit growth – perhaps justify the multiple. Just remember: the stock has enjoyed an almost uninterrupted rise since early 2003. If you start driving past a lot of new fast food outlets, it might be time to lighten up on McDonald’s.

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