Market Mad House

In individuals, insanity is rare; but in groups, parties, nations and epochs, it is the rule. Friedrich Nietzsche


The Incredibly Shrinking McDonald’s

McDonald’s (NYSE: MCD) is one of the craziest stocks around; its’ shares are still ridiculously overpriced, even though its’ revenues are in free fall.

Chart watchers know that Mickey D’s revenues have been falling for about three straight years, since June 2014. At the end of second quarter 2014; McDonald’s revenues were $28.30 billion, by June 2017 they had sunk to $24.18 billion. That made for a decline of $4.01 billion; which looks like the death spiral to me.

The death spiral occurs when a company’s revenues never stop dropping. At some point the company finds itself unable to cover expenses and collapses. That’s what happed to Radio Shack and what is happening at Sears Holdings (NASDAQ: SHLD).

Companies in the death spiral have one of two choices; bankruptcy or a sale to a deep-pocketed competitor or investor. For example the Roundy’s supermarket chain sold itself to Kroger (NYSE: KR) in 2015, and Safeway sold itself to Cerberus (a private equity fund) to avoid collapse.

Is McDonald’s in the Death Spiral?

Despite its’ revenue loss; McDonald’s is not in the death spiral yet because it is still making a lot of money.

McDonald’s reported a net income of $5.079 billion on June 30, 2017. That was an increase from March; when it reported $4.777 billion in net income, and June 2016 when it reported $4.733 billion.

Nor is it just net income; the ycharts’ data indicates that McDonalds’ is still generating a lot of cash. Some evidence that there is still a lot of money to be made under the Golden Arches includes:

  • A free cash flow of $1.116 billion on March 31, 2017.


  • A profit margin of 23.06% on June 30, 2017. This was up from 21.4% in March 2017 and 17.44% in June 2016.

  • Assets of $32.12 billion on March 31, 2017.


  • Cash and short-term investments of $2.412 billion on March 31, 2017.


  • $5.858 billion in cash from operations on March 31, 2017.


  • A market capitalization of $126.17 billion on August 1, 2017.

  • An enterprise value of $151.24 billion on August 1, 2017.


Why McDonald’s is no Longer a Value Investment

All this will have many people wondering if McDonald’s is a value investment. After all McDonald’s is a good company with a strong brand that makes a lot of money, that’s in some trouble.

The answer is no because MCD is overpriced; there is simply no way the stock is worth $154.80 a share; that’s what it was trading at on August 1, 2017. Instead it is worth around $100 a share because the company’s future is uncertain.

The reason for that is the nature of the fast food business in the United States and around the globe. McDonald’s simply has too much competition ranging from “quality burger” operations like Shake Shack (NYSE: SHAK) to supermarkets like Kroger (NYSE: KR) and Whole Foods (NASDAQ: WFM); which are now selling a wide variety of hot entrees in direct competition with eateries, to quick serve restaurants like Chipotle (NYSE: CMG).

This handout photo from McDonald’s DC shows new kiosk ordering screen inside the redesigned restaurant at 2228 New York Avenue NE in D.C. The fast food chain is rolling out its “Experience the Future” restuarants in the region. Twenty-five of the redsigned restaurants will be open by late spring. (Courtesy McDonald’s DC)

Even in the breakfast sphere, McDonalds has to contend with morning eats from Taco Bell and Burger King. There’s also all the other choices out there such as pizza, even Noodles.

Beyond the competition there is brand dilution which is a huge problem for McDonald’s in the United States. There’s a whole generation of Americans that associate the Golden Arches with “cheap, lousy burger” and “tacky promotions.” For every Baby Boomer that has cherished memories of going to McDonald’s as a child; there’s a Millennial or Generation Xer who avoids it like the plague.

Why Technology May Not Save McDonald’s

An even greater menace is presented by UberEats and GrubHub (NYSE: GRUB). Those services allow a hungry person to order a wide variety of hot food at the touch of an app and have it delivered. A real menace for McDonald’s would be Kroger or Amazon (NASDAQ: AMZN) buying GrubHub and using it to deliver hot meals from supermarkets. Remember Amazon is trying to buy Whole Foods.

Nor is technology necessarily the savior for McDonalds that some investors expect. Kitchen robots like Flippy, might make it possible for any eatery to offer the kind of speed and prices McDonald’s is known for with far greater variety ad quality. Quality burgers might be everywhere which threatens McDonald’s whole reason for existence.

Even the order kiosks are a potential threat because any restaurant can install them. If the kiosks works at McDonald’s they’ll quickly appear at Burger King, Taco Bell and Five Guys and wipe out any edge Mickey D’s got from installing them.

Is McDonald’s an Income Investment?

McDonald’s is also a questionable income investment because stockholders were punished with a negative return on equity of 1.76% on March 31, 2017.

It is still a great dividend stock; however, investors were paid 94¢ on June 1, 2017. That was an increase from 89¢ on August 30, 2016.

McDonald’s is a stock to watch, buy MCD if it drops below $100 a share, because there’s a great dividend and a lot of future income potential here. Investors should pounce if the company can increase its’ quality and harness new technologies.