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Once again, eyes are on McDonald's (NYSE: MCD ) for a reason that should be obvious: the Olympics. McDonald's has been a proud sponsor of the Olympic Movement for more than 35 years. More importantly, Ricky Berens and Michael Phelps gorged at McDonalds after winning their gold medals on Tuesday night: two Quarter Pounders with cheese, one Big Mac, one six-piece McNugget, two medium french fries, and a medium McFlurry, which account for 3,300 calories. What's going on under those golden arches?
For starters, let's recap
In its recent earnings announcement, McDonald's reported second-quarter EPS of $1.32 versus consensus of $1.38. For comps by region, U.S. + 2.9% vs. consensus of +2.5%, Europe +5.1% vs. consensus of +0.4%, and APMEA came in as +3.5% vs. consensus of +2.5%. FX had a $0.07 impact on EPS vs. guidance of $0.07-$0.09 and is expected to impact 3Q EPS $0.08-$0.10. The company returned $1.6 billion to shareholders in the form of dividends and share repurchases. In summary, the gloomy quarter was the result of austerity measures in Europe and the sovereign debt crisis that kept people cooking at home instead of dining outside, weakening same-store sales, and negative impact of currency and the commodity prices. All this resulted in a 3% drop in the stock post-earnings.
Commodity price pressure seems to be easing
Although MCD saw 4% commodity inflation in Europe, it brought down guidance to 2.5%-3.5% for FY2012. In addition, management has now locked in the demand for commodities to hedge any risk pertaining to a spike in prices due to a recent drought in the U.S. This should ease pressure on earnings going forward.
Europe, austerity measures, and competition
Europe comps were up 3.8% in the second quarter vs. 5.9% last year. Europe restaurant margins were 19.3%, down 30bps year over year because of increasing costs in labor and commodities.
Challenging consumer spending requirement
It's a challenging global consumer spending environment, and lagging sales in April and May show that consumers now have several alternatives to fulfill their craving for Quick Service Restaurants. We did a quick survey, and our sample of QSR clients thought that better value was offered at In&Out, Burger King (NYSE: BKW ) , and Five Guys. It's pretty clear to us that McDonald's has heavy competition from consumer with access to various alternatives.
That being said, does McDonald's have an advantage simply because of the location of its stores? A 50,000 square-foot corner location with two signs visible from two major streets might surely works to their advantage.
According to our experts at NPD group, we are a culture of constantly on-the-go and hungry people. In 2011, Americans made 12.4 billion visits to fast-food drive-thrus, a 2% rise from 2010. Hamburger joints, unsurprisingly, were our favorite for drive-thru orders: 57% of all visits to McDonald's, Burger King, Wendy's (Nasdaq: WEN ) , and other fast-food hamburger restaurants were of the drive-thru variety.
So, is McDonald's a leader because they have great advertising, offer a lovable and consistent menu along with the $1 value menu, and now offer healthier foods?
McDonald's has had a very good run in the last decade since they announced "Plan To Win" and started focusing on quality and value instead of only size. McDonald's is currently trading at 16.2 times versus its three-year range of 13-18 times and average of 15.6 times since 2005. Its peer group consisting of Starbucks and Yum! Brands are trading at 25 times and 20 times, respectively. Also, a 3% yield on the stock might help support the shares to trade in a range. There are no near-term catalysts to be a mover and shaker for the stock, so perhaps MCD is just a safe haven for those who want to invest in the Quick Service Restaurant Space.
We think the risks to the McDonald's story revolve around four things:
- A drop in consumer spending both in the U.S. and in Europe, which could continue to hurt sales going forward
- Foreign currency pressure, which could impact sales, margins, and earnings
- An increasing cost in commodities and labor
- A growing competitive landscape
(Click here to access free, interactive tools to analyze these ideas.)
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