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Why Marsico's Lovin' McDonald's

Jason Stipp

Jason Stipp: In your portfolio, the biggest holding is McDonald's and you also have Yum! Brands and then a couple of other companies that could be considered not in the same sort of business, but businesses that tend to do well when the economy is doing not as well, Wal-Mart and Cosco. So, I wanted to get your take on those holdings and if you see them working together or if there is sort of different reasons for having them and why especially you have McDonald's with such a good opportunity?

Tom Marsico: Well, first of all there is a fundamental growth story at McDonald's and basically they are providing food in more day parts - so breakfast, lunch, dinner and late night. They have done that here first in the United States and now they are starting to do that in Europe and then they will move that to Asia and to South America. So, you have these revenue streams that keep piling up on top of each other. So, now actually in the United States, McDonald's serves more breakfast than any other restaurant chain.

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They have recently added coffee to their menu and this was a whole refresh of their menu several years ago when they started adding better food for you. So, they have chicken wraps now and they have what's considered to be good food, white meat chicken - actually they are the largest chicken company too as far as selling chicken as the mainstream item on their menu. So, they're not just a burger company or a fry company.

But, as they expanded to this beverage market, beverages in general have gross margins of 80%, so there is a lot of water in any beverage.

Jason: For a food margin what's the comparison?

Tom: The food margins are probably down around 35% gross margins.

Jason: So much more profitable.

Tom: Yeah, it is a much more profitable business and it starts with their coffee platform. Now, you have seen a rollout, nationally here in the United States, of their full coffee program similar to products that you have seen at Starbucks at a much lower price. So, that gets people into the stores at a different part of the day market. And everyone thought that people would only come in and buy coffee in the morning, but what they found is that's an incremental buy to the breakfast items that they are selling. So actually their ticket size for breakfast has actually expanded providing another layer of revenues.

It is trading at a very low multiple. It is trading at 13.1 times earnings. We think it is a 12 to 15% grower. Currency has been a headwind the first half of this year; it will be less of a headwind in the second half of the year.

Their growth internationally will accelerate. And Russia has been a very robust market for them, Eastern Europe has been a very good market for them and they are doing very well in a very compromised economy in Great Britain.

Their comp store sales throughout this whole economic period never went negative. I don't know of any other retailer that can really speak to that. Their traffic didn't go negative.

So, that tells you the power of their brand, the power of their product and the product or their value. Now, as people get more comfortable in the economy, they will start trading up to other items on the menu.

So frankly, if you look at their value menu, it is pretty stable over all types of economic periods. When you have a weaker economic period, it might go up two or three percentage of their total sales, but it is not a dramatic move. So, I see it.

The other thing that is a major advantage too is their spending on marketing. Their next five largest competitors added up don't spend as many marketing dollars as McDonald's spends.

So, if you look at the experience of Budweiser in the beer market, they took their market share from 20% to 40% just because of their ability to spend in the market and create a good product. The same way, I think McDonald's has that same opportunity and also that's their opportunity internationally.

So, we see this as a core holding, it pays a higher dividend yield than what treasuries are paying right now. It is about 3.8%, so I think that it is a very safe holding. The balance sheet is very conservative and they are also buying back their stock. So I think that they have been great stewards of their capital.

Jason: So it sounds like I was going to ask you, it could have had potentially a little bit of a tailwind in the recession, but what you seem to be finding is that people will still be coming to McDonald's perhaps ordering a few different things but will still be there throughout a recovery time? [crosstalk]

Tom: They might buy a two or three dollar Frappuccino now.

Jason: And on the coffee side, there was a lot of talk with the coffee wars with Starbucks, how do you think that that's playing out? Do you think that Starbucks is losing share that McDonald's is gaining, or do you sort of see enough room for both in the markets that they are serving?

Tom: Absolutely there is room enough for both, but I think that Starbucks was targeting more of an upscale market or more of an aspirational market. McDonald's sells to the masses. So I think to the extent that Starbucks has some trouble here, I think they are refocusing their strategy, they are refocusing their price points. And so that model is evolving, but with the locations that McDonald's have, I think it is very compelling that people will stop there to get more of their beverages.

So they are going to expand their beverages also into case drinks, so you can get a Soho drink there, you can get maybe a Arizona ice tea there, I don't know what brands they are going to have, but this is going to be the next level of their development of this beverage franchise.

Jason: Very interesting. Tom, thanks so much for your ideas today and your level of detail in talking about some of your stock. I truly appreciate it.

Tom: Great. It is nice to do this, thank you very much.

Jason: Sure. For Morningstar, I am Jason Stipp. Thanks for watching.

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