A few years ago, Tesco was a popular value stock. It was written up four times on Value Investors Club. Warren Buffett was a shareholder. While the company's recent earnings were disappointing, its historical results were fantastic and bulls thought a turnaround was likely.
Today McDonald's is a popular value stock. It was written up twice on VIC earlier this year. A large hedge fund, Glenview Capital, is a shareholder and has touted the stock. While the company's recent earnings are disappointing, its historical results are fantastic and bulls think a turnaround is likely.
With the benefit of hindsight, we know that Tesco was a value trap. I think McDonald's is another value trap. The arguments that investors have made for buying McDonald's are similar to the arguments people made for buying Tesco.
Bad same-store sales are blamed on loss of focus
When they were written up on VIC, Tesco and McDonald's both suffered from deteriorating same-store sales.The VIC authors argued that this was a result of the companies losing focus.
After Tesco became the largest grocer in Britain, it made an ambitious effort to expand internationally. In June 2012, kevin155 wrote, "I believe that since Tesco was so focused on their growth initiatives, some of the best management talent and resources has been foucused outside the UK."
In April 2015, cmg90 wrote, "In 2013-2014, MCD’s SSS turned negative as a result of strategic misdirection, operational inefficiencies, and disenfranchised franchisees." He added, "Menu proliferation (100 items added over last decade) has hurt order speed (doubled order time in many stores) and order accuracy."
A good investment for the next few years
In 2011, cowboy wrote, "We believe an investment in Tesco plc offers an excellent risk/reward for those with a 3-5 year time horizon."
This past April, gordon703 wrote, "I believe MCD represents a compelling risk/reward investment opportunity over the next 3-5 years."
A wonderful company with scale advantages, etc.
Both the Tesco and the McDonald's bulls are backward-looking: they portray TSCO/MCD as a legendary company and its ongoing problems as a temporary deviation from phenomenal long-term results.
According to the VIC authors, "Tesco is one of the world's great retailers" and "a good franchise with a strong long-term history of growth and returns" while "MCD is a very high quality business with a irreplaceable brand" and "market leading position in a growing, defensive category, significant scale advantages and a highly stable business model."
Each company has economies of scale. Tesco "enjoys significantly lower COGS than its competitors, as well as operational economies of scale" while McDonald's has "a margin of safety provided by its significant scale advantages."
Each company owns valuable property. "MCD's sacrosanct real estate could be worth ~$140B alone," while "Tesco owns ~70% of its real estate. Based on management’s estimate of its properties’ worth, the stock currently trades at approximately that value." Another Tesco bull argued that "According to management this property is worth GBP38bn, which is more that the current enterprise value of GBP33bn."
Each company promoted a promising manager from its international business to the top spot. Tesco's former CEO, Phillip Clarke, "did a very good job establishing new foreign markets as well as growing them to their current sizes today." McDonald's "new CEO Steve Easterbrook is credited with successfully turning around the McDonald’s UK business in the mid / late 2000s."
This is a superficial comparison, and Tesco and McDonald have many important differences: they're headquartered in different countries, they operate in different industries, etc. I don't know if McDonald's will implode the way Tesco has, but I think theMcDonald's bulls are making many of the same flawed arguments that the Tesco bulls made.
Another important difference between Tesco and McDonald's is valuation: Tesco traded at 10-13x earnings before its share price collapsed, while McDonald's trades at 21x this year's expected earnings. McDonald's has all the makings of an undervalued turnaround except that it isn't undervalued.