McDonald's Earnings Are Tough to Swallow

McDonald's first-quarter results left a lot to be desired, but risk-averse investors still have a lot to like about the golden arches.

Apr 23, 2014 at 10:00AM


Fast-food giant McDonald's (NYSE:MCD) is under a lot of pressure. Over the past few years, consumers, particularly those in the United States, have demonstrated a noted loss of appetite for McDonald's offerings.

Investors were hoping for any reprieve they could get their hands on when the fast-food behemoth reported first-quarter earnings, but that largely didn't happen. Instead, all investors got was a confirmation that consumers in the U.S. are voting with their feet and turning away from McDonald's in favor of restaurants that are viewed as healthier alternatives, much like Chipotle Mexican Grill (NYSE:CMG) and Panera Bread (NASDAQ:PNRA).

That's not to say McDonald's has nothing to offer you. Rather, the company is doing well in other parts of the world. In particular, McDonald's is growing in Europe and its emerging market segment. However, the U.S. remains McDonald's biggest geography, and declining sales here place a limit on its growth potential. As a result, investors might just have to get used to the 'new normal' McDonald's finds itself in.

Americans not lovin' it
McDonald's struggles in the United States continued in the first quarter. Comparable-store sales, which measure sales at locations open at least one year, fell 1.7% during this period. This more than offset solid performance across the globe. In Europe, same-store sales rose 1.4%, and comparable sales increased 0.8% in the company's APMEA (Asia-Pacific, Middle East, and Africa) segment. Overall, McDonald's comparable sales inched up 0.5%, and diluted earnings per share fell 2% after excluding currency impacts.

This indicates that for better or worse, McDonald's still needs the U.S. if it's going to grow. That means it has a lot of work to do. Its menu additions over the past year, including the Mighty Wings, didn't pan out. And, customers have had to grapple with poor service, including longer wait times.

McDonald's Chief Executive Officer Don Thompson acknowledged these issues as primary drivers for underperformance in the United States, Germany, Australia, and Japan. In the company's earnings release, Thompson stated the company will be focused on stabilizing these key markets, although further specifics were not provided.

Look elsewhere for growth
For investors interested in finding faster growth from their investments, other fast-casual restaurants such as Chipotle Mexican Grill(NYSE:CMG) should be considered. Chipotle will definitely satisfy your hunger for growth. As McDonald's continues to lose customers in the United States, Chipotle is one of the beneficiaries since it's widely viewed as a healthier alternative with better-sourced food.

Chipotle's comparable-restaurant sales jumped 13% in the first quarter. It's doing precisely what McDonald's can't do, which is to get more people through the door. The increase in same-store sales in the first three months of the year was due to higher traffic as well as an increase in average check size.

Another company eating McDonald's lunch is Panera Bread(NASDAQ:PNRA); it grew comparable-restaurant sales by 2.6% and diluted earning per share by 16% last year. Panera succeeded on the same fronts as Chipotle, drawing higher average checks thanks to retail price increases. Going forward, management sees these tailwinds lasting throughout the year. Panera recently affirmed its full- year targets. Management sees same-store sales growth of 2%-4% this year, driven by positive transaction growth.

Meanwhile, you should be aware of the heightened risk profiles of Chipotle and Panera. Both companies trade for sky-high valuations when compared to McDonald's. Chipotle and Panera have forward earnings multiples of 32 and 21, respectively, compared to 15 times for McDonald's. This means that expectations are extremely high, as Chipotle and Panera appear to be priced for perfection.

This can backfire if earnings growth doesn't meet analyst expectations. (Note that Chipotle lost 6% of its market value after releasing its first-quarter earnings report even though its growth numbers were extremely impressive.)

The Foolish takeaway
McDonald's isn't likely to be the next hot growth story. It's a huge company with an entrenched global footprint. And, its traditional offerings are seen as unhealthy by consumers in more developed nations like the United States. This will likely keep a lid on its growth potential, so investors looking for high growth should consider Chipotle or Panera.

Meanwhile, McDonald's is a classic value and dividend play. It can still offer you a modest valuation with significant downside protection through its hefty 3.3% dividend. If you're interested in one of these stocks, you should carefully weigh your expectations and the risk you're willing to take.

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Bob Ciura owns shares of McDonald's. The Motley Fool recommends Chipotle Mexican Grill, McDonald's, and Panera Bread. The Motley Fool owns shares of Chipotle Mexican Grill, McDonald's, and Panera Bread. 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.

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Jun 12, 2015 at 5:01PM

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David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't 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.

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