MCD gets absolutely blasted in barrons this weekend.
"the stock could sell 40% lower."
From Alan Abelson's column
<<Last week, Geoff Tirman, proprietor of Talisman Capital, a hedge fund in Little Rock, Arkansas, talked a bit here about some possible buys in the badly trashed telecommunications sector. As we noted at the time, Geoff is a shrewd and successful investor, quite at ease among the techs, but whose tastes and investment interests are eclectic.
We also noted that he's far from shy about shorting stocks and promised to let him sound off on his negative preferences. Which is precisely what we intend to do at this very moment. One final comment: Whether he's long or short, Geoff's a rare money manager who does his own research and does it quite exhaustively (he sure exhausts us sometimes when he describes his findings in detail).
Enough of the intro. Pure and simple, Geoff's favorite short is McDonald's. Right, the hamburger king. And although the stock is down sharply from its 12-month high of almost 40 (it closed Friday a hair under 28), he's convinced it is still very vulnerable.
As the decline in the shares suggests, investors are not unmindful of the company's diminished prospects and, in any case, concerns couldn't help but be aroused by its recent disappointing performance. More specifically, it has wound up with slightly lower per-share earnings in each of the past two fiscal quarters.
What bothers Geoff most -- and is responsible for both the limp earnings showing and the steep fall in share price -- is the impact of mad-cow disease on the company's operations in Europe. That impact, of course, was only magnified by the outbreak of hoof-and-mouth disease. Geoff has spent a lot of time in Europe during the past year or so and has witnessed with some astonishment the amazing collapse of beef consumption there. In most of Western Europe, he reports, beef demand is off by 80% and the urge to munch on a quarter-pounder has shrivelled apace.
For a good part of the past decade, Europe has been a prime source of growth for the company. And obviously, there's no way the remarkable distaste for beef is not going to translate into a serious hit for McDonald's. How serious? By Geoff's reckoning, it means that the company's European operations will at best break even and, more likely, lose money.
Europe, he notes, accounts for 33% of McDonald's revenue and operating profit. If it breaks even in Europe, the company will take a cut of $1.1 billion in yearly operating income, which translates into 77 cents a share. What that would have meant last year was earnings of 85 cents a share, instead of the $1.47 Big Mac actually reported.
Even without the effects of mad cow and hoof-and-mouth diseases, Mcdonald's has not enjoyed exactly scintillating growth. Over the past five years, revenue has averaged a moderate 7.8% annual advance. Operating income, meanwhile, has risen at only a 4.7% yearly pace. Scarcely, he remarks, sizzling gains for a company whose stock trades at four times book value, two times sales and nearly 19 times earnings.
Geoff also points out that the company has been a steady buyer of its own shares over the past five years, picking up some 100 million shares, or roughly 7.5% of the total number outstanding. That share shrinkage, he adds, has been responsible for a good chunk of the rise in per-share profits during this stretch.
Meanwhile, the company's financials have been losing glitter. Debt, as a percentage of total assets, is up 25% in the past five years (to 39% currently); as a percentage of equity it is up 40%, to 92%; as a percentage of EBIDTA, it is up 23%, to 204%, and debt, net of cash, is up 55%. None of these ratios, Geoff is quick to assert, suggest the company is in dire financial straits. But they all spell decline.
Nor is he very much impressed with the company's thrust into new ventures to offset slowing growth in its main business. He views such diversification as costly, extremely unlikely to provide any "kick to numbers" and, indeed, a good bet to eat into operating margins and ultimately add to McDonald's woes.
Geoff's deepest concern is that mad-cow disease will crop up in this country. He has been putting in a lot of time getting a read on transmissible spongiform encephalopathy, including testing, regulations, oversight and the like. One result is that he has "zero confidence" in the system now in place that's the creature of the new inspection procedures mandated in 1997. Another result is that he's now a confirmed non-beef eater.
Nor does he find reassuring the additional regulations put into effect by the FDA that same year to ensure that feed mills properly label their products as not containing any rendered animal parts and that the latter are not to be fed to cows and other ruminants. (Mad-cow disease is believed transmitted by cows consuming the remains of infected animals). According to the FDA itself, compliance with its labeling requirements is only in the upper 60% range. Which, even to the mathematically challenged, suggests rather a sizable noncompliance.
His point is that virtually all the emphasis on enforcement is directed toward preventing imports of tainted cattle, when it's certainly possible -- he would argue inevitable -- that the source of the disease will be home grown.
McDonald's, to be sure, has gone all out to try to ensure that its suppliers rigidly adhere to the restrictions designed to prevent mad-cow disease. But, as Europe proved, an outbreak anywhere in the U.S. could wreak havoc on its business.
Even ex such a disaster, Geoff thinks the stock could sell 40% lower. |
