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McDonald’s Kicks Pink Slime Early

RENAISSANCE TECHNOLOGIESMcDonald’s (MCD) has stayed at the forefront of fast food innovation for years – it introduced salad, healthy sides and specialty coffees right as consumer preferences started to bend in that direction – but the company has also made some changes before consumer demand ever dictated it. Take the issues with “pink slime” for instance.

Known in the industry as “finely textured beef,” pink slime is made with the scraps of meat left after the choice cuts are removed. It is banned for human consumption in the UK. In the US, beef processors make it safe for humans by treating it with ammonium hydroxide, which is used in many fertilizers, household cleaners and homemade explosives. Cooking celebrity and healthy eating advocate Jamie Oliver began a campaign speaking out against finely textured beef in April 2011, and has since drawn a large amount of media attention.

McDonald’s was actually ahead of the mark on this one. In a press release, McDonald’s said that it made the decision to phase out finely textured beef at the beginning of 2011 and completed the transition to “100% USDA-inspected beef- no preservatives, no fillers, no extenders- period” by August, 2011.

The company is not alone – Burger King, Yum Brands (YUM), Wendy’s (WEN) and Jack in the Box (JACK) also stopped using “pink slime” – but not all these companies are as well-positioned as McDonald’s.

McDonald’s is very attractive right now. It recently traded for $98 a share and pays a $2.80 dividend (2.9% yield). The company has strong stock performance, returning almost 35% last year. It also has enjoyed strong earnings increases, boosting its earnings per share by nearly 15% compared to the same quarter last year. While McDonald’s did fall short of its peers’ average revenue growth of roughly 14%, it was still able to increase its revenue by nearly 10%.

The company is priced well too. Compared to its future earnings, McDonald’s is priced 15.21 times its expectations, versus an average of 22.35 for its industry. It is also priced lower than its peers relative to its book value (6.80 vs. 7.51) and cash flow (13.69 vs. 15.62). Jim Simons’ Renaissance Technologies and Clifford Fox’s Columbus Circle Investors are both fans of this company.

At roughly $71 a share, rival YUM Brands, the company that owns KFC, Taco Bell and Pizza Hut, is priced a little higher than McDonald’s relative to its earnings, with a forward price to earnings ratio of 18.81, but it had greater revenue growth, increasing by 15.4%. YUM Brands stock increased by almost 23% last year and it pays a modest $1.14 dividend (1.60% yield). Mason Hawkins’ Southeastern Asset Management, Ken Griffin’s Citadel Investment Group and Steve Cohen’s SAC Capital Advisors like YUM Brands.

Wendys recently traded at $5 a share with an 8 cents dividend (1.60% yield). At this level, the stock is priced at 22.66 times its forward earnings. This may be high but the company is priced at just 0.98 times its book value. However, the numbers just aren’t there. Its quarterly revenue growth, year over year, is just 5.60%. Like Wendys, Jack in the Box is also priced higher at 15.46 times its earnings and its quarterly revenue growth is even lower, coming in at a 1.80% loss compared to the same quarter last year. The stock recently traded for $24 a share and does not pay a dividend.

Of these companies, I like McDonald’s and YUM Brands best – McDonald’s because the pricing just can’t be beat and the company looks well-positioned and YUM Brands because the diversification that comes from having three distinct brand identities cannot be discounted.

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