SIVY ON STOCKS from money.com
May 14, 2001

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Supersize this stock!

For six months, McDonald's has been battered by nonstop bad news. Now the
outlook is improving and the stock appears poised for a strong rebound.

By Michael Sivy

Since last fall, McDonald's has been hit with one problem after another.
The weak U.S. economy has been bad enough. But since half the company's
sales and operating profits come from overseas, McDonald's has been
severely hurt by the weak euro and the renewed scares about mad-cow disease
and hoof-and-mouth disease, which have reduced European beef consumption.
Finally, though, the outlook appears to be improving. Earnings trends may
remain unfavorable through the summer, but by the fourth quarter, business
should be back on track. That should mean a big payoff for contrarians who
scoop up McDonald's [MCD] today at prices just a few dollars above the
stock's 52-week low.

I last recommended the stock in December at $31 a share. At that price, 35
percent below the record high set in 1999, McDonald's looked like a great
value play, and the stock rallied 12 percent going into January. But it
began slipping back as soon as it became evident that business would not
immediately turn around. In fact, earnings per share fell 12 percent in the
first quarter.

Basically, McDonald's has been beset by a string of problems that have been
compounded by poor management choices. The first is the economic slowdown
in the U.S., which has depressed growth in same-store sales. In addition,
the company has relied too much on promotions and other marketing gimmicks,
which haven't been working well in the tougher economy.

More serious, however, has been the falloff in profits from foreign sales,
particularly in Europe. To compensate for the decline in beef consumption
and the chronically weak euro, which has reduced the dollar-value of
profits earned in Europe, McDonald's has been increasing the pace of
new-store openings. But that has only undercut existing stores, and
profitability has suffered.

Fortunately, those problems are all transient. As the U.S. economy picks up
again, domestic results should improve -- particularly if McDonald's is
successful with innovations such as cafes that offer Italian-style coffee
at prices cheaper than Starbucks charges.

International results should improve as the company diversifies its menu to
offer a wider range of non-beef items. But the key to better European
results is a revival in beef consumption, and a rebound in the euro, which
is likely after coins and bills actually start circulating in January. And
already, there is evidence that the beef scare has peaked and that
consumers are starting to order more burgers.

There's no question that McDonald's stock is cheap. The shares trade at 17
times earnings, compared with multiples that have been regularly in the
mid-20s since 1996. True, the rebound has taken longer than I expected. But
I think that we'll see earnings growth pick up toward year-end, and then
continue at a 12 percent-plus compound rate over the next five years. In
addition, the P/E should rise once it's clear that prospects are improving.
That combination should make McDonald's an above-average holding for
patient conservative investors.

###

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http://www.money.com/depts/investing/sivy/index.html

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