This Restaurant Stock is Not That Attractive Anymore

Gaurav is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

McDonald's (NYSE: MCD) with its above average dividend yield has maintained a reputation as a great retirement stock over many years, but the stock is under pressure due to the deteriorating macro environment. The pressure is due to growing competition and lower customer spending. This was apparent in the numbers announced during the last earnings call where McDonald’s missed on both EPS and Revenue estimates. I believe McDonald's is likely to continue seeing headwinds in its business going forward. Here are some of my key concerns.

High Competition Ahead

McDonald’s has been able to post good numbers despite competitive concerns. However, the competitive environment has never been more intense. With global competitors Wendy’s (NASDAQ: WEN) and Burger King (NYSE: BKW) giving McDonald’s a run for its money, McDonald’s is starting to lose market share. Wendy has been working on a new look for its restaurants along with attractive menu options,  and Burger King has gotten rid of its largely hated Monarch mascot in an effort to give a new look to its stores. Looking at menus, both Wendy’s and Burger King have extended their breakfast offerings. These strategies have so far resonated well with consumers as both Burger King and Wendy saw an increase of 1.4% and 2.8% in 3Q global sales.

Europe Continues To Head Downwards

Europe is facing an economic crisis. With austerity across Europe, where McDonald’s generates ~40% of its operating income looking to increase, I believe that McDonald’s could take more blows with low consumer spending and lower same store sales growth. The company has already started seeing the effects as SSS in Europe were down to 2.2% in Q3 from 3.8% in Q2. McDonald’s price increases don’t appear to resonate with consumers, I believe that McDonald’s growth will moderate in the coming months as consumers start exploring other fast food options.

The Impossible Choice

With the government becoming increasingly sensitive with regulations of food in order to avoid food borne illness in both emerging and developed markets, I believe that McDonald’s will face pressure on operating margins over time. China, which is presumed to be the main growth driver for McDonald’s, is going through inflation in labor and food prices which has already begun to outpace revenue growth. In short run, high inflation would further lead to deficit in skilled labor and a deficit of local resources that eventually will affect the operating margins. The main problem McDonald’s faces is that it is caught between two choices: Increasing price to cope with the increasing labor costs which will reduce the popularity of McDonald’s with customers or take losses that will not resonate well with investors.

The Bottom Line

While McDonald’s will continue to pay high dividends, I believe that dividends alone could not justify going long on McDonald’s. With McDonald’s facing pressures to increase prices, I believe it is guaranteed to lose value for investors. I believe that McDonald’s has lost its stature as a “Total Return Vehicle” and hence rate it as a sell.

gauravguru has no positions in the stocks mentioned above. The Motley Fool owns shares of McDonald's. Motley Fool newsletter services recommend 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.If you have questions about this post or the Fool’s blog network, click here for information.

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