McDonald's Weak Earnings Set to Continue

McDonald's is set to report quarterly results on Jan. 23, with sales and earnings expected to be nearly flat. Failed promotions and weakness in the United States, where rivals like Wendy's are becoming more competitive, will weigh on the company's results.

Jan 18, 2014 at 10:45AM

Fast-food giant McDonald's (NYSE:MCD) is set to release its fourth-quarter earnings on Jan. 23 before the bell, with failed promotions like Mighty Wings and weak sales in the U.S. likely to weigh on the results. McDonald's attempts to put healthier items on its menu have done little to drive sales in the United States, with domestic comparable-store sales rising just 0.1% through the end of November.

With fourth-quarter results expected to be essentially flat compared to the same quarter last year, it's unlikely that McDonald's investors will have much to cheer, as competitors like Wendy's (NASDAQ:WEN) continue to post solid results.

What analysts are expecting
Fourth-quarter revenue is expected to rise just 2.3% to $7.1 billion, up from $6.9 billion last year. For the full year, analysts expect revenue to come in at $28.1 billion, up 2% compared to 2012. If analysts are correct, 2013 will be the second year in a row that McDonald's has grown revenue at just 2%, although the Street expects growth to accelerate a bit in 2014.

Earnings per share is expected to rise a penny to $1.39 for the quarter, with the full- year result increasing to $5.55, 3.5% higher than last year. Earnings growth is also expected to pick up in 2014, with analysts looking for a 6.8% rise in EPS for the full year. Over the next five years, the average analyst estimate for annual earnings growth is a hair more than 8%. These estimates would require a significant improvement, however, and should be taken with a grain of salt.

What's going wrong at McDonald's?
For the last decade, McDonald's has been steadily growing its revenue and expanding its margins, in the process becoming a highly profitable company with a significant economic moat. But the industry has become more competitive, with chains like Chipotle stealing away younger, health-conscious customers in the United States. While McDonald's has tried introducing healthier items, like the McWrap, this has failed to revive domestic growth.

Burgers and fries are far from dead, however, and other chains may be stealing away some of McDonald's market share. Wendy's recently announced an expected 1.9% same-store sales increase for its fourth quarter, with particularly strong results in the second half of 2013 driven by premium, limited-time products like the Pretzel Bacon Cheeseburger. Earnings are expected to increase by a factor of five compared to the fourth quarter of last year, driven both by higher sales and a decrease in the number of company-operated restaurants.

McDonald's seems to be unable to hit the promotion sweet-spot like Wendy's has done, with Mighty Wings flopping and other premium items failing to move the needle. Innovation is the key, and McDonald's seems to be falling behind the competition.

One area where McDonald's is pushing hard is coffee, both in the United States and abroad. In the US, premium coffee drinks have been added to stores in an effort to boost sales, although the added complexity for employees has caused the restaurant-level efficiency to take a hit. McDonald's international coffee strategy looks more promising, with stand-alone McCafe stores being built in both Europe and Asia. Most of McDonald's future growth will come from international markets, and the expansion of both the McDonald's and McCafe brands in countries like China should help the company grow faster in the coming years.

The bottom line
McDonald's weak growth should continue in the fourth quarter, as promotions and premium menu items have failed to boost sales in the United States. McDonald's has a growth problem, and international markets may be the key to solving it, but maintaining its industry-leading margins as it expands will be a challenge.

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