Is There Any Hope for McDonald's?

Does the recent quarterly data bode well for McDonald's?

May 13, 2014 at 4:00PM

Hamburger giant McDonald's (NYSE:MCD) hasn't proven to be a great buy over the last few years. Its year-over-year capital appreciation stands at a negative 0.44% as opposed to the S&P 500's return of 19%. This is also the case with Yum! Brands (NYSE:YUM), which didn't succeed last year due to issues at its KFC restaurants in China. However, Burger King Worldwide (NYSE:BKW) performed better in relative terms than these two restaurant giants.

Now, the big question is: will McDonald's make a comeback? Let's find out.

Quarterly analysis 
On April 22, McDonald's reported earnings for the first quarter. The company reported $6.7 billion in revenue, which fell short of the Street's expectations of $6.72 billion. Net income also fell 5% to $1.2 billion, which resulted in earnings per share of $1.21, 4% below the year-ago quarter's earnings. McDonald's earnings also missed the consensus estimate of $1.24 per share.

Same-store sales in the US fell by 1.7%. This is the sixth consecutive quarter in which McDonald's has missed Wall Street's comps forecast. In Europe, comps increased by 1.4% while in the Asia Pacific, Middle East, and Africa, or APMEA, region comparable sales grew by 0.8%.

Is there hope for McDonald's? 
According to McDonald's, one of the primary reasons for the drop in earnings was bad winter weather in the US. Tough competition in the country also continued to hamper its sales. 

Over the last few months, McDonald's has been criticized for making its menu more complicated, which resulted in a longer serving time. This in turn discouraged a lot of customers, who eventually went to other restaurants. McDonald's CEO Don Thompson said that the restaurant would add more preparation tables at U.S. locations to accommodate more ingredients.

Unfortunately the company's efforts to get its business back on track haven't worked so far, as McDonald's is still suffering from a slow serving time and this metric is key to fast-food chains' success these days. Adding more preparation tables to support ingredients for diversified menus should pay off but the progress hasn't been that quick. "We continue to view McDonald's domestic business as hampered by a menu with far too many items on it, which is slowing average service times," Mark Kalinowski at Janney Capital Markets said.

Moreover, record-high beef prices, higher labor costs, and protests from the company's minimum-wage workers will put more pressure on McDonald's in the coming days. On top of this, severe competition from the likes of Yum! Brands, Chipotle Mexican Grill, Burger King, and Wendy's will keep on dividing the restaurant industry's market share.

Valuation
In almost all of my previous articles, I have emphasized the fact that McDonald's dividend is one of the top growth dividends in the restaurant industry. It's still a high-liquidity company with strong cash per share of $2.83, so increasing the dividend shouldn't be an issue for McDonald's.

However, we can see that the company's stock has provided a capital return of just 6% for the last two years. As the company keeps posting weak comparable sales in the US, investors are losing faith in the restaurant. McDonald's is trading at a low forward price-to-earnings ratio of 16, which testifies to this fact. According to the sell side, McDonald's has a one-year target price of $105, which reflects an upside potential of just 5% that isn't enough by any stretch of imagination.

Yum! Brands and Burger King
Last year, Chinese officials reported that they found antibiotics in KFC's chicken. This, along with the avian flu outbreak, had a dramatically negative impact on the company's sales. However, Yum!'s first-quarter earnings suggest that the restaurant is finally getting back on track. The company posted earnings per share of $0.87 to beat Wall Street's expectations of $0.84 per share. Earnings were also up 24% from the comparable quarter of last year. As China is one of the biggest markets for the company, it is of foremost importance to Yum!; same-store sales for China were also up 9%.

On the other hand, Burger King has partnered with AT&T to launch AT&T Wi-Fi services for all of its U.S. restaurants. The upgraded service, "WHOPPER Wi-Fi," is more user-friendly and has enhanced connectivity and will replace the current Wi-Fi network. As a lot of Burger King's customers user their smart phones and tablets to log on to the Internet, improving the service will definitely have a positive impact on the customer experience. Burger King has provided year-over-year capital appreciation of 38% to investors.

Bottom line
McDonald's has given meager returns to investors for the last two years. It continued to face a tough economic environment and intense competition in the U.S., which resulted in declining comparable sales in the country. The company's CEO has taken the right steps to revamp the business so that it can reduce its serving time. However, these initiatives can't turn the company around that quickly.

McDonald's is doing pretty well internationally, which is evident from its recent comps data. However, for McDonald's to make a speedy recovery, it has to make a comeback in the U.S. market, and this seems highly unlikely in the near future.

Given the fact that it will take some time before McDonald's will show some signs of improvement with the new initiatives, I remain pessimistic about the company at this moment. In short, don't buy McDonald's.

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Waqar Saif 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. 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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