At roughly $89 per share earlier this week, McDonald's (NYSE:MCD) stock was down about 8% so far this year, which is bad in itself, but is even worse because the S&P 500 is up 7% over the same period. The fast-food giant is suffering from a number of headwinds. Its core low-income demographic in the United States has not benefited from the gradual economic recovery nearly to the same extent as higher-income consumers. In the emerging markets, which were supposed to be McDonald's saving grace, the company is still grappling with a bruised public relations image resulting from a food-quality scare in China this year.
McDonald's has definitely underperformed in 2014, and it's frustrating for shareholders to see the stock go nowhere while rivals like Chipotle Mexican Grill zoom higher. However, while McDonald's fundamentals have suffered this year, it's important to put the situation in the proper context. The negative sentiment surrounding McDonald's has become so pervasive that you might think it were in danger of going out of business, but this is not the case.
For all its problems, McDonald's still has much to offer. Earnings are down 10% through the first three quarters this year, which is discouraging but hardly cause for panic. The stock is cheap and pays a solid 3.8% dividend yield, and management is finally making headway in key strategic initiatives that will fuel McDonald's turnaround.
Signs of progress
One of the biggest disappointments for me this year was McDonald's slow response to things that were clearly dragging it down. For example, in its first three earnings releases, management repeatedly referred to its overly complex menu as a weight on the company, but announced no action on the matter. Over the past few years, McDonald's added several items, often slightly different iterations of an existing sandwich or beverage, to its menu. This followed the flawed logic that when it comes to customer choices, more is always better. But management did not properly differentiate between more choices and customization, and they are definitely not the same.
Chipotle has customization nailed to perfection. Customers select every ingredient that goes into their meals. At the same time, orders are placed and filled in a streamlined, assembly line fashion that cuts down on wasted time. By contrast, McDonald's simply loaded up its menu with more offerings, hoping to do the same thing. The concept was poorly executed, which resulted in ballooning wait times and increasing customer dissatisfaction.
Fortunately, McDonald's is about to do something about this. The Wall Street Journal recently reported that the company will remove eight food items from the menu, along with five Extra Value Meals, with the potential for more cuts to come. In addition, according to other news outlets, McDonald's will aggressively push its "Create Your Taste" initiative in which customers can select from a list of ingredients and toppings.
This is an important step in responding to the times. Consumers clearly want a different experience than they have been getting from McDonald's, and it is a relief to see management finally waking up to the new reality.
Why now might be a good buying opportunity
McDonald's turnaround is far from complete, and investors are unlikely to see improvement in the company's earnings for at least a few more quarters. The emerging markets are still ugly. In fact, comparable-restaurant sales fell 4% in the Asia-Pacific, the Middle East, and Africa region in November. Renewed fears of recession in Europe could hit McDonald's as well. Comparable sales on the Continent fell 2% last month.
But there are also positive signs. First is the collapse in gas prices, which serves as something of a tax cut for consumers, particularly low-income consumers. In addition, McDonald's stock offers a solid 3.8% dividend yield, which is well-protected by earnings. McDonald's distributes only about two-thirds of its profit as a dividend. And it has raised its dividend each and every year since the first payout in 1976, so there's no reason to think the dividend is in any danger.
At around $90 per share, McDonald's trades for about 18 times earnings, which is a slight discount to the market's multiple. If earnings bottom out early next year and begin to grow again, which is possible thanks to McDonald's restructuring efforts and share buybacks, the Golden Arches might provide attractive total returns going forward.
Bob Ciura owns shares of McDonald's. The Motley Fool recommends 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.