Relax! McDonald's Is OK (At Least For Now)

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So far, this year hasn't been all that great for shareholders of McDonald's (NYSE: MCD  ) , the largest fast food chain in the world. Despite the stock rising about 7.5% year-to-date, enthusiasm for the company has just been so-so. The underlying reason here is that the company, with a market capitalization of $94.5 billion, is having a difficult time growing its business.

Perhaps the starkest reminder about this reality can be found by looking at the company's most recent quarterly results. In an earnings release announced earlier today, the company posted earnings of $1.52 per share (one penny above analyst estimates) and revenue of $7.32 billion, just shy of what the market expected.

Positive but Mediocre Results
Looking at the same quarter a year ago, we see that the company increased its revenue by about 2.4% from $7.15 billion to $7.32 billion. Most of the increase appears to have come about from the company adding additional stores because same-store sales rose by only 0.9% (with 0.7% coming from the United States and the remaining 0.2% from Europe). When we compare revenue for the first three quarters of the year versus the first three quarters of McDonald's 2012 fiscal year, we see that the results are slightly worse, with sales rising by 1.9% from $20.61 billion to $21.01 billion.

Although these results are lackluster to say the least, there is some positive news that the market seems to be overlooking today. When examining McDonald's margins, we actually see that they have improved to some degree. For instance, the company has seen its net profit margin increase to 20.8% in this quarter versus 20.3% in the same quarter a year ago. What is most exciting is that this move upward has been driven not by one-time tax reductions but, instead, by its ability to reduce operating expenses. This is shown by the fact that its operating margin has increased to 33% this quarter versus 32% a year ago.

However exciting this may be, what's more exciting for a shareholder of McDonald's is that this also doesn't appear to be the result of one-time cost reductions. This is best shown by comparing the company's nine-month net profit margin and operating margin to its nine-month margins for its 2012 fiscal year. By doing this, we can see that with a net profit margin over the past three quarters of 20% and a net profit margin of 19.7% for the same quarters a year ago, and an operating margin of 31.2% this year versus 31.1% last year, the company has seen a moderate increase in income and a meaningful increase in its ability to reduce costs.


Despite all the good but nonetheless mediocre news that McDonald's released today, it also announced some headwinds that it has to contend with. Chief among these is the company's declining prospects in its Asian/Pacific, Middle East, and African (APMEA) operations. While the rest of the world saw moderate improvements in the company's business, same-store sales declined by 1.4% in its APMEA operations. The blame should be held, primarily, in China, Japan and Australia, which contributed significantly to this segment's operating income falling by 12% as the economic environment in this region has seen downward pressure.

Part of the problem facing McDonald's is that it has become increasingly challenged by new entrants in the dining segment. However, the new entrants have not been in the traditional fast food industry, nor have they been in the casual dining industry; they have created an industry of their own; quick-casual dining. Although more and more companies are coming out of the woodwork under the quick-casual model, the wave of new entrants that have served McDonald's the most bitter dish is headed by Chipotle Mexican Grill (NYSE: CMG  ) and Panera Bread Company (NASDAQ: PNRA  ) .

Chipotle, for instance, has seen tremendous growth in recent years. This is illustrated by the company's 105% increase in revenue and 255.5% increase in net income over the past five fiscal years. Panera has also seen attractive growth as shown by its 64% increase in revenue and 157.3% increase in net income over the same time horizon. In juxtaposition, McDonald's has seen its revenue and income rise as well, but to the much lower tune of 17.2% and 26.7%, respectively. Though this is far from bad, it goes to show that consumers are becoming less price conscious and more quality-oriented as healthier (not to mention not much more expensive) options are becoming available.

Foolish Takeaway
Based on an analysis of McDonald's earnings release, we can see that things for the company are alright, but far from great. Though its metrics have improved and its revenue is still on the rise, the company has to find a way to contend with its declining popularity in its APMEA segment while maintaining its focus on growth within the United States.

Furthermore, McDonald's needs to remain cognizant of changing consumer tastes in dining style and quality, something that it appears to be in denial about. If it can realize where its greatest threats lie (in its own complacency and in the hands of new market entrants like Chipotle and Panera), then perhaps it can see business improve moving forward. However, a failure to come to these realizations could mean the beginning of worse times for the company, as well as its shareholders.

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