McDonald's Disappoints: Buying Opportunity or Time to Run?

McDonald's is delivering disappointing financial performance, but the stock looks undervalued. Is it a buying opportunity or a declining company?

Apr 23, 2014 at 1:15PM

G

Source: McDonald's.

McDonald's (NYSE:MCD) is delivering lackluster financial performance lately, and competition from successful fast-casual players like Chipotle Mexican Grill (NYSE:CMG) as well as traditional fast-food competitors like Burger King (NYSE:BKW) represents a considerable challenge for the company. On the other hand, McDonald's is attractively valued, and the risks seem to already be incorporated into current valuation.

Is McDonald's an undervalued investment or a declining business?

Not "lovin' it"
Total consolidated revenues increased by an uninspiring 1%, to $1.6 billion, during the first quarter of 2014. Constant currency sales did marginally better with a 3% increase during the period, but global comparable-sales performance was quite weak with an increase of only 0.5% versus the first quarter of 2013.

Operating income declined by 1% year over year, and earnings per share came in at $1.21, a decline of 4% versus the same quarter in the prior year, and lower than the $1.23 per share forecast on average by Wall Street analysts.

Performance in the U.S. was particularly weak with a 1.7% decline in comparable sales during the quarter, and a fall of 3% in operating income in the country. According to management, these results reflected "negative comparable guest traffic amid challenging industry dynamics and severe winter weather."

Europe was relatively better: McDonald's reported an increase of 1.4% in comparable sales and a growth rate of 6% in operating income in the Continent. On the other hand, the APMEA region delivered a worrisome decline of 0.8% in comparable sales, and a dip of 10% in operating income.

Competitive pressure
McDonald's is facing a series of considerable challenges. The trend toward healthier food and lackluster consumer spending represent a problem for many companies in the fast-food industry; besides, the competitive landscape is becoming increasingly challenging lately.

Fast-casual restaurants are gaining ground versus traditional fast-food chains. These restaurants offer higher-quality ingredients for a marginally more expensive price, while maintaining the overall speed and customer experience of fast-food chains, and the concept is resonating remarkably well with customers.

Chipotle Mexican Grill is the undisputed growth leader among fast-casual restaurants, and the company is delivering extraordinary performance while clearly outgrowing McDonald's by a wide margin.

Chipotle Mexican Grill announced last week an explosive increase of 24.4% in sales during the first quarter of 2014, to $904.2 million. Comparable-store sales jumped by 13.4% during the quarter, and management mentioned increased traffic as the main reason for this extraordinary performance.

Traditional fast-food chains are also gaining ground versus McDonald's via successful product innovation in the last several quarters. Burger King is scheduled to report earnings for the first quarter of 2014 on April 25, but the company is performing better than McDonald's on the back of successful new products such as its Big King sandwich and low-calorie french fries Satisfries.

For the fourth quarter of 2013, Burger King delivered an increase of 5.7% in systemwide sales, and a growth rate of 1.7% in systemwide comparable sales. Burger King also delivered a big increase of 14.3% in adjusted EBITDA during the quarter, so the company is outgrowing McDonald's when it comes to both sales and earnings performance.

Tempting valuation
The challenges and difficulties affecting McDonald's are certainly considerable, but the company is trading at compelling valuation levels, so many of the problems affecting McDonald's seem to be already reflected in the stock price.

Looking at ratios like P/E, forward P/E, and dividend yield, McDonald's trades at a big discount versus competitors such as Chipotle Mexican Grill and Burger King.

Valuation

Data source: FinViz.

The dividend yield should provide some downside protection at current levels considering that McDonald's has proven its ability to increase dividends through good and bad times. In an unquestionable sign of financial strength, the house of Ronald McDonald has raised its dividend each and every year since 1976.

Bottom line
McDonald's valuation and rock-solid dividend provide a convenient entry point for investors who are willing to patiently wait for the company to accelerate revenue growth via successful product innovation. Until -- or unless -- that happens, however, returns will most likely remain subdued, because current performance does not merit a much higher valuation for the company.

Top dividend stocks for the next decade
The smartest investors know that dividend stocks simply crush their non-dividend-paying counterparts over the long term. That's beyond dispute. They also know that a well-constructed dividend portfolio creates wealth steadily, while still allowing you to sleep like a baby. Knowing how valuable such a portfolio might be, our top analysts put together a report on a group of high-yielding stocks that should be in any income investor's portfolio. To see our free report on these stocks, just click here now.

Andres Cardenal has no position in any stocks mentioned. The Motley Fool recommends Burger King Worldwide, Chipotle Mexican Grill, and McDonald's. The Motley Fool owns shares of Chipotle Mexican Grill and McDonald's. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

1 Key Step to Get Rich

Our mission at The Motley Fool is to help the world invest better. Whether that’s helping people overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we can help.

Feb 1, 2016 at 4:54PM

To be perfectly clear, this is not a get-rich action that my Foolish colleagues and I came up with. But we wouldn't argue with the approach.

A 2015 Business Insider article titled, "11 websites to bookmark if you want to get rich" rated The Motley Fool as the #1 place online to get smarter about investing.

"The Motley Fool aims to build a strong investment community, which it does by providing a variety of resources: the website, books, a newspaper column, a radio [show], and [newsletters]," wrote (the clearly insightful and talented) money reporter Kathleen Elkins. "This site has something for every type of investor, from basic lessons for beginners to investing commentary on mutual funds, stock sectors, and value for the more advanced."

Our mission at The Motley Fool is to help the world invest better, so it's nice to receive that kind of recognition. It lets us know we're doing our job.

Whether that's helping the entirely uninitiated overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we want to provide our readers with a boost to the next step on their journey to financial independence.

Articles and beyond

As Business Insider wrote, there are a number of resources available from the Fool for investors of all levels and styles.

In addition to the dozens of free articles we publish every day on our website, I want to highlight two must-see spots in your tour of fool.com.

For the beginning investor

Investing can seem like a Big Deal to those who have yet to buy their first stock. Many investment professionals try to infuse the conversation with jargon in order to deter individual investors from tackling it on their own (and to justify their often sky-high fees).

But the individual investor can beat the market. The real secret to investing is that it doesn't take tons of money, endless hours, or super-secret formulas that only experts possess.

That's why we created a best-selling guide that walks investors-to-be through everything they need to know to get started. And because we're so dedicated to our mission, we've made that available for free.

If you're just starting out (or want to help out someone who is), go to www.fool.com/beginners, drop in your email address, and you'll be able to instantly access the quick-read guide ... for free.

For the listener

Whether it's on the stationary exercise bike or during my daily commute, I spend a lot of time going nowhere. But I've found a way to make that time benefit me.

The Motley Fool offers five podcasts that I refer to as "binge-worthy financial information."

Motley Fool Money features a team of our analysts discussing the week's top business and investing stories, interviews, and an inside look at the stocks on our radar. It's also featured on several dozen radio stations across the country.

The hosts of Motley Fool Answers challenge the conventional wisdom on life's biggest financial issues to reveal what you really need to know to make smart money moves.

David Gardner, co-founder of The Motley Fool, is among the most respected and trusted sources on investing. And he's the host of Rule Breaker Investing, in which he shares his insights into today's most innovative and disruptive companies ... and how to profit from them.

Market Foolery is our daily look at stocks in the news, as well as the top business and investing stories.

And Industry Focus offers a deeper dive into a specific industry and the stories making headlines. Healthcare, technology, energy, consumer goods, and other industries take turns in the spotlight.

They're all informative, entertaining, and eminently listenable ... and I don't say that simply because the hosts all sit within a Nerf-gun shot of my desk. Rule Breaker Investing and Answers contain timeless advice, so you might want to go back to the beginning with those. The other three take their cues from the market, so you'll want to listen to the most recent first. All are available at www.fool.com/podcasts.

But wait, there's more

The book and the podcasts – both free ... both awesome – also come with an ongoing benefit. If you download the book, or if you enter your email address in the magical box at the podcasts page, you'll get ongoing market coverage sent straight to your inbox.

Investor Insights is valuable and enjoyable coverage of everything from macroeconomic events to investing strategies to our analyst's travels around the world to find the next big thing. Also free.

Get the book. Listen to a podcast. Sign up for Investor Insights. I'm not saying that any of those things will make you rich ... but Business Insider seems to think so.


Compare Brokers