Is It Time to Buy Fast Food?

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

Sales for McDonald’s (NYSE: MCD) climbed more than expected in May, showing an increase of 2.4%, 0.3% above expectations. The gains can be attributed to menu innovations targeted at health-conscious customers, such as the Egg White Delight and a new line of wraps. The gains were not limited to the U.S., as Europe, the Middle East, and Africa showed sales increases of 2.0% collectively and Asia’s sales ticked up 0.9%.

So far this year, McDonald’s has been unable to keep up with the S&P 500 due to poor first-quarter results, lagging 3% behind the index’s 16% clip.

Can McDonald’s show strong growth?

According to the McDonald’s 10-Q for the first quarter of FY13, future sales growth is predicated on restaurant unit expansion and comparable-store sales. Given this, the company projects about a 2.5% increase in sales throughout the rest of 2013. This increase would be largely due to the net 1,135 restaurants added in FY12.

McDonald’s is looking to expand further in China, where it opened 256 restaurants in FY12. Currently, more than 1,700 franchises are operating in China; McDonald’s expects to push that number above 2,000 in FY13. Worldwide, it expects net additions of 1,200 to 1,300 restaurants. This is not a significant change from FY12, and the FY14 projections from unit expansion should reflect this.

For McDonald’s, a 1% increase in sales corresponds to roughly a $0.04 increase in diluted earnings per share. This translates to a $0.10 increase over FY13 and a $0.20 increase over the next two years assuming projections hold and the currency is constant.

McDonald’s success going forward

The success of McDonald’s is dependent upon several key elements

1. Its ability to introduce new menu offerings and the success thereof

2. The impact of marketing initiatives (direct marketing and social responsibility initiatives) on sales

3. Its ability to respond effectively to negative press and success of imaging

Recently, McDonald’s has been remarkably successful at introducing new menu offerings that appeal to a broad range of consumers. This continued innovation is essential to maintaining sales in the face of competition in the marketplace.

Also essential to sales is marketing—McDonald’s needs to maintain product differentiation and continually draw in new consumers. Its re-imaging and social responsibility initiatives are integral to the perception of the company in society at large. If the company is perceived as socially responsible and succeeds in re-imaging itself as somehow more accountable than the average fast-food chain, it will be able to fend off attacks on the brand more easily.

Competition

McDonald’s is subject to competition from Burger King Worldwide (NYSE: BKW) and Wendy’s (NASDAQ: WEN), and must differentiate its fast-food experience. How are Burger King and Wendy’s doing by comparison, and how will they perform in the future as compared to McDonald’s?

Burger King showed a sales decrease of 1.4%. Furthermore, its EBITDA increased by just 4.5% from the first quarter of FY12. However, its diluted EPS increased by 49%, and the company authorized a $200 million share-repurchase program. For comparison, Wendy’s EBITDA increased by 21% in the same period.

Burger King recently completed a re-imaging program, which doesn’t bode well for the company. It needs to start seeing returns from that program, and fast. Repurchasing shares will help support share prices, but sooner or later it will need to show stronger financials.

As the result of a management shuffle by 3G Capital, Burger King's CEO Bernando Hees will leave his post by July 1. He is to be replaced by Daniel Schwartz, the current CFO. Schwartz and Josh Kobza (his successor as CFO) have said that they will continue to emphasize value offerings, which gave the company a slight boost in sales in March.

In January and February, the company aggressively pushed its premium offerings and was rewarded with a decrease in sales. The balanced approach advocated by the new management team could be a success, but the company's recent track record demands a cautious approach when investing.

Wendy’s is at the beginning of its own re-imaging program, and it has already seen sales tick upward. Wendy’s is following a similar strategy to McDonald’s, relying on menu innovation and health-conscious options. It has also launched its own share-repurchase program, although it is not nearly as ambitious as Burger King’s ($200 million) or McDonald’s ($350 million+). Of the three companies discussed, Wendy’s sits in the best position.

Foolish conclusions

McDonald’s is capable of exhibiting growth in the mid-term and long-term. Its strongest competition will come from Wendy’s, which currently shows stronger numbers than McDonald’s. Although McDonald’s is capable of showing growth, it needs to continue innovation in its menu offerings. Its strong showing in May can be largely attributed to its new menu options, and that’s a good model for the company going forward.

In a stronger economic climate, McDonald’s needs to continue offering new products to recruit new consumers and keep old ones. Both McDonald’s and Wendy’s will follow this model, and it’s really a question of who does it better. Right now, Wendy’s has the upper hand according to its financials, but that’s not set in stone. Watch both of those companies, and be ready to jump if the advantage swings one way or the other.

McDonald’s turned in a dismal year in 2012, underperforming the broader market by 25%. Looking ahead, can the Golden Arches reclaim its throne atop the restaurant industry, or will this unsettling trend continue? The Fool's top analyst weighs in on McDonald's future in a recent premium report on the company. Click here now to find out whether a buying opportunity has emerged for this global juggernaut.


Hunter Hillman 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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