Investors Need Patience at the Golden Arches

Venerable McDonald's strong global presence provides advantages over smaller rivals Burger King and Wendy's.

May 12, 2014 at 3:20PM

McDonald's (NYSE:MCD) first-quarter earnings were nothing to write home about. Nonetheless, they had some bright spots as the fast food giant transitions its menu and pricing. The payoff requires looking past the company's results for the next few quarters, however. While the food may cater to people who are in a hurry, investors will be better served by taking a more patient approach.

Fellow fast-food sellers Burger King Worldwide (NYSE:BKW) and Wendy's (NASDAQ:WEN) do not offer investors the same long-term opportunity. In a competitive industry, it is better for investors to put their trust in a company that has proven itself through the decades.

A worldwide company
McDonald's is a global company. This provides benefits, such as geographic diversity. The advantages of this are readily apparent with a look at the company's latest earnings report.

The company reported a 0.5% increase in comparable sales. The average check increased, although the company served fewer customers in the United States as well as the Asia/Pacific, Middle East, and Africa, or APMEA, region. Even though McDonald's reported lower traffic in those regions, its revenue was $6.7 billion, a respectable 3% increase on a constant-currency basis. This metric removes the impact of foreign currency translations, which can have volatile effects but do not have anything to do with the underlying business. Therefore, it makes sense to use this basis when comparing year-over-year figures. Operating income rose 1% to over $1.9 billion.

Breaking it down by region, the United States has been challenging for the company. This is an important market, accounting for 30.7% of the first quarter's top line. McDonald's revenue fell 2% to $2.05 billion and its operating income fell 3% to $820.8 million. Comparable sales fell 1.7% as fewer customers visited McDonald's. Aside from the new menu, many restaurants saw their results hurt by the extreme cold and snow in this past winter. Although weather has been a convenient excuse among retailers and restaurant companies, in this case it rings true. People were trapped indoors after snowstorms, and the cold weather made them reluctant to venture outside on other occasions.

However, there is another reason for optimism. Customers need to adjust to McDonald's changed menu offerings. McDonald's offers a Dollar Menu and More. However, unlike competitors such as Burger King and Wendy's, its offerings appear to offer value, rather than just a price increase. This seems like a smart pricing strategy.

For instance, the dollar menu for breakfast items such as the Sausage McMuffin remains in place. Other menu items will include more food. For instance, the Bacon McDouble has two beef patties, cheese, bacon, onions, ketchup, mustard, and pickles for $2. The Buffalo Ranch McChicken still costs $1, or you can get bacon for $1 more.

Even with a lower customer count, revenue increased 5% in the APMEA region to over $1.6 billion. Comparable sales rose 0.8%. However, operating income fell 2% to $345.1 million. This region covers a large geographic area. China was a bright spot there, although Japan continues to struggle.

Meanwhile, Europe helped pick up the slack. This region represented 40% of the first quarter's top line and drove the most revenue. Revenue rose 4% on the continent and comps increased by 1.4%. This helped lead operating income 4% higher to $752.5 million.

In all, diluted earnings per share fell by $0.05, or 4%, to $1.21. However, foreign currency translations knocked $0.03 off this year's figure.

The competition hasn't been doing much better
The tepid results may be an industry phenomenon. Burger King reported first-quarter comparable-sales growth of 2% on a constant-currency basis. However, it saw just a 0.1% increase in the U.S. and Canada.

Burger King's total revenue fell 26.5% to $240.9 million, but its income from operations rose 28.2% to $131.3 million. Diluted earnings per share were up 70%, to $0.17. Nonetheless, it is difficult to compare these metrics since the company has converted its ownership structure primarily to franchises rather than company-owned restaurants.

Wendy's uses a different reporting schedule, but its earnings from continuing operations were just $0.12 a share last year, although this was much higher than the $0.02 it reported a year ago. Granted, it is converting some restaurants to franchise ownership and this hurts the top line, but its revenue fell 0.7% to less than $2.5 billion. Lower expenses helped operating income increase 10.1% to $135.1 million. Perhaps Wendy's can keep the momentum going through its brand transformation initiatives, but its share price has risen about 37% over the past year. This suggests future gains might be harder to come by since much of the good news is baked into the price.

Final Foolish thoughts
Shareholders will receive rewards while they wait for McDonald's results to improve, as they will collect a 3.2% dividend yield. Moreover, the company has raised its dividend in every year since 2008. Most recently, in December the payment received a boost to a quarterly rate of $0.81.

The company is committed to returning cash to shareholders, while it remains focused on improving the guest experience through quality service and menu offerings. This year, management expects to spend $5 billion on share repurchases and dividends, on top of the $4.9 billion it shelled out last year.

McDonald's valuation looks reasonable, too. Trading at a trailing P/E of 18 times, this compares favorably to its rivals. Burger King sports a P/E of 37, while Wendy's price is an astronomical 74 times trailing earnings. Along with the dividends, the potential price appreciation will no doubt leave McDonald's shareholders feeling satisfied.

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Lawrence Rothman has no position in any stocks mentioned. The Motley Fool recommends Burger King Worldwide and McDonald's. The Motley Fool owns shares of 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.

4 in 5 Americans Are Ignoring Buffett's Warning

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Jun 12, 2015 at 5:01PM

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