Income Investors: Put McDonald's on Your Menu

McDonald's MCD maintained its strong momentum during the third quarter, with same-store sales coming in modestly ahead of our estimates and consensus across all regions (including 4.4%, 4.9%, and 3.4% comparable sales gains in the U.S., Europe, and Asia/Pacific, Middle East, and Africa regions respectively) and solid profitability increases (consolidated operating income grew 14% for the quarter, or 8% excluding favorable currency translation, and margins expanded 15 basis points to 33.4%). It also appears that this momentum is continuing into the fourth quarter, with consolidated global comparable sales expected to increase 4%-5% in October.

With McDonald's thriving in various economic climates across the globe, we have even greater conviction in our wide moat rating and believe the stock is best suited for investors looking for exposure to a rapidly expanding global middle class but also wanting protection from market volatility and still-elevated food cost pressures. With its strong brand name and economies of scale, we expect minimal sales impact from potential austerity measures in the United States or Europe, even if McDonald's should announce selective price increases during its conference call. Elevated commodity costs may keep margins in check through the first half of 2012 (though the impact to McDonald's should be less severe than the rest of the industry thanks to strong relationships with suppliers), but as these pressures ease, we believe the stage will be set for even greater earnings and cash flow upside.

We plan to make a few minor adjustments to our model following Friday's conference call, but we do not anticipate a material change to our $92 fair value estimate. While the stock is trading at only a modest discount to our fair value estimate, we believe it may be attractive to income investors looking to adopt capital-preservation strategies, especially with an annual dividend that yields roughly 3% after a 15% increase in September.

--R. J. Hottovy, CFA