It's been something of a steady year for investors in McDonald's (NYSE:MCD), as the world's biggest fast-food chain by sales has largely tracked the performance of the S&P 500, with the former posting gains of 3.5% and the latter up 4.5% year-to-date. Despite this, McDonald's is currently trading at the upper end of its one-year range of $92.22-$103.78, with shares priced at $100.42. Does this mean that the stock is set for a fall, or is McDonald's a buy right now?
McDonald's first quarter performance
On the face of it, the first quarter performance of McDonald's was largely disappointing. For example, consolidated revenues increased by only 1%, while diluted earnings per share (EPS) were 4% lower in the first quarter of 2014 than they were in the first quarter of 2013. That's disappointing and it seems surprising that shares have not experienced a decline as a result.
However, drilling down past the headline numbers reveals two key points. Firstly, McDonald's suffered from a negative currency impact in the first quarter, which caused revenue and EPS numbers to appear worse than they really were. For example, excluding the negative impact of currency translation, McDonald's revenue increased by 3%, while EPS fell by 2% rather than 4%.
Secondly, the McDonald's results were a tale of two halves. In other words, non-US performance was surprisingly strong, while US performance was disappointing. For example, in Europe comparable sales increased by 1.4% when compared to the first quarter of 2013. Furthermore, operating income increased by 4% in constant currencies, with noteworthy performance occurring in the UK, France and Russia.
This is slightly surprising, since Europe continues to lag the US in terms of wider economic growth. Indeed, US performance from McDonald's was markedly behind that of Europe at a 1.7% decline in comparable sales. A key reason for this significant difference could have been adverse weather conditions, although McDonald's continues to experience a relatively high level of competition in the US. As such, it will focus on improving the restaurant experience and optimizing its menu going forward.
Focusing on two major competitors to McDonald's
Although Burger King's (UNKNOWN:BKW.DL) market capitalization is dwarfed by that of McDonald's ($99 billion versus $9 billion), its product line is strikingly similar. However, results for the first quarter of the year were very different for Burger King, with the company reporting an increase in global comparable sales of 2% and an increase in EPS of 67.8% when compared to the first quarter of 2013. Interestingly, Burger King delivered positive comparable sales growth in all of its regions – including the US – although it too suffered from adverse weather conditions. Despite this, it still posted positive comparable growth numbers for the US of 0.1%, which is considerably better than McDonald's (minus 1.7%) and even better than the 3% fall that Burger King experienced in the first quarter of 2013.
Meanwhile, Yum! Brands (NYSE:YUM) delivered worldwide sales growth of 4%, with the company delivering particularly strong growth in China. This is important because Yum! Has targeted China as a key long-term market for the business, so growth in Chinese sales of 17% is highly encouraging – especially when it includes 9% same-store sales growth. As with McDonald's and Burger King, US performance was relatively weak and Yum! explained this was a result of adverse weather conditions that were a major factor in all three divisions delivering negative comparable sales growth (KFC same-store sales fell by 3%, Pizza Hut by 5% and Taco Bell 1%). Despite this, Yum! Was still able to report 24% growth in EPS in the quarter, which was aided by a worldwide restaurant margin increase of 3.3% when compared to the first quarter of 2013.
What does the future hold for McDonald's?
With all three companies reporting a significant impact from adverse weather conditions in their first quarter results, it's clear that the disappointing comparable sales numbers for McDonald's in the US do not tell the whole story. Furthermore, the company reported a strong showing in Europe where its strategy to improve the consumer experience and optimize the menu appear to be bearing fruit. Furthermore, currency headwinds affected negatively on the reported numbers and caused the first quarter of 2014 to be, in my view, unrepresentative of McDonald's true performance.
Is McDonald's a buy at current levels? With shares currently trading on a price to earnings (P/E) ratio of 18.2, they appear to be fairly valued given that the S&P's P/E is 18.5. When compared to sector peers Yum! And Burger King, though, McDonald's looks cheap, since their P/Es are 31.5 and 35.5 respectively. However, both of these companies are expected to deliver significantly higher earnings growth rates in 2014 than McDonald's (46.6% for Yum! and 31.9% for Burger King versus 4.5% for McDonald's).
As a result of uncertainty over its US performance and a valuation that appears to be in-line with the market, I believe it could be worth waiting for share price weakness before buying shares in McDonald's.
Robert Stephens has no position in any stocks mentioned. The Motley Fool recommends Burger King Worldwide 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.