By David Nelson, CFA
Few companies have dominated their categories more than McDonalds (MCD) and Coca Cola (KO). Since 1982 both are up well over 5000%.
Warren Buffett who seems to love iconic brand names has owned both. Coke of course is still one of his larger positions however Mr. Buffett sold out his position in (MCD) by 1998. Investors would have done very well to stick with the shares.
Fast forward 15 years and we can see both have fallen out of favor and are dramatically underperforming the market. Over the last 5 years in one of the biggest bull markets in a generation both are underperforming to a degree that may force even their biggest supporters to question their allegiance.
Mr. Buffett is on record saying; “I wouldn’t think of selling a share of Coke.” Even Warren sells stocks now and then and I think another year or two of poor performance may even shake the Oracle of Omaha.
When you look at the 5, 2, 1 and Year to Date relative performance charts one thing becomes crystal clear. Both (KO) and (MCD) seem to be in lock step significantly underperforming the S&P (SPX).
5 Year (MCD), (KO) & (SPX) Relative Performance Chart
Many who own McDonald’s (MCD) point to the 3.4% yield and a track record of raising the dividend. Is the 1.5% yield advantage really worth giving up the 40% two year performance gap between McD’s and the index?
Lock Step
When you look at the performance charts it’s hard not to notice their fortunes and failures seem to be closely aligned. So what’s going on that has two of the most iconic brands stumbling so badly?
2 Year (MCD), (KO) & (SPX) Relative Performance Chart
Healthier Lifestyles
Americans want to live healthier life styles and somehow a Big Mac and Coke just doesn’t fit in that picture. We’ve watched how Whole Foods (WFM) started from almost nothing offering organic healthier food becoming a juggernaut in the health food industry. Now healthier food has gone main stream. Walk into any supermarket and you’ll find booming health food sections.
The contrast between McDonald’s (MCD) and Chipotle (CMG) is telling. McDonald’s has had several quarters of lackluster sales and many analysts point to a lack of catalysts to turn the ship around. Global Same Store Sales continue to be in negative territory. June came in at (-3.5%) with consensus expecting +0.1%. In addition the company says they expect this trend to continue in July. Chipotle (CMG) sales trends are just the opposite. SSS are up a staggering 17.3% year over year.
It’s true the consumer is challenged but it seems they can scrape together enough money for a burrito, just not a Big Mac. While McDonald shares aren’t expensive trading just north of 16x 2014 earnings, it isn’t cheap either.
Things Go Better With Coke
Well maybe not these days. While Coke can point to some growth overseas, here in the states sales have lost their fizz. Morgan Stanley analyst Dara Mohsenian says in a recent note their 2.5% average organic sales growth over the last two years in Q2 is the worst since the 2008-09 downturn.
Like McDonald’s I believe the push for a healthier lifestyle is weighing on the category. Valuation is hardly compelling trading at 19x 2015.
Emotional Choices
Sometimes as investors we get emotional over stocks, especially if they’ve made money for us in the past. Buffett has all but admitted this several times saying “I love Coke, I love management and I love the directors.” Sounds pretty emotional to me. Back in May I wrote Buffett-Talks the Talk, Can He Walk the Walk.
I was referring to his decision not to vote his shares against management’s pay package even though he said in an interview with CNBC’s Becky Quick he thought the package was excessive. Back then hedge fund manager David Winters was trying to force the board to re-think executive compensation.
While the debate continues surrounding what I believe are excesses in the C-Suite one thing isn’t up for debate and that’s Coke’s anemic growth.
Can McDonald’s (MCD) and Coke (KO) turn these battle ships around? Last week Restaurant News reported; A group of 27 McDonald’s owner-operators representing 231 domestic restaurants have given the most pessimistic outlook for the next six months of business in the history of Janney Capital Markets’ quarterly McDonald’s Franchisee Survey, placing a majority of the blame on the brand’s senior leadership.
Coke management seems focused on controlling costs, a plan put in place by their Chief Executive Muhtar Kent. While this may give some support near term the question investors need to ask is “What will they do to improve organic sales growth?”
Meanwhile the faithful in both stocks have been treading water for a pretty long time and the opportunity cost needs to be considered.
Are they shorts? Probably not. Both are still generating lots of cash and they are go to names during market downturns and corrections. However, the support shares receive from their dividend may be tested as the world economy improves and the likely rise in rates that follow.
For now investors would do better if they push themselves from the table and trade in their Big Mac and Coke for a more healthy choice.
*Source Reuters
