Despite Missing Q3 Earnings, Is This Fast Food Giant a Buy?

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McDonald’s (NYSE: MCD) saw an almost 4% pullback in its stock price after it released third quarter results late last week. McDonald’s did beat revenue estimates, but came in light on earnings. EPS finished at $1.43 for 3Q, compared to the $1.47 consensus.  The company noted continued weakness given economic uncertainty domestically, in Europe, and in China.

McDonald’s is one of the top ten most popular restaurant stocks among hedge funds, competing with the likes of major fast food chains The Wendy’s Company (NASDAQ: WEN), Burger King Worldwide (NYSE: BKW) and Jack in the Box (NASDAQ: JACK). Wendy’s recently saw a downgrade from Janney Montgomery Scott LLC based on same store sales that could come in flat or down 2% for September. Janney also reduced its 3Q EPS estimates from $0.05 to $0.04.

Wendy’s had notable investor, Mason Hawkins, as its second largest fund owner, with other managers Steven Cohen, D.E. Shaw, and Ken Griffin being modest owners at the end of last quarter. One insider has also recently gotten bullish on the company. However, we remain reserved on Wendy’s, which is trading at a forward P/E of 20. Our concerns relate to the company’s ability to focus on international expansion. Wendy’s expects to double its international presence by 2016.

Burger King was dragged down with the poor earnings release of McDonald’s, losing almost 5% on Friday. Burger King is working on refranchising its stores, having completed a refranchising of one third of its operations in 2Q. The cloudy outlook for Burger King is tied to the company’s performance post refranchising, as 2013 sales are expected to be down 35%. Although a post-refranchised Burger King may be a stronger company in the long run, we remain cautious as it completes these initiatives over the next twelve months.

Jack in the Box is being punished by McDonald’s earnings the most, but the latter is not completely at fault. The McDonald’s news is bringing into question Jack in the Box’s burger chain, while the Chipotle miss is putting pressure on Jack’s Qdoba brand. Jack is down over 7% following the news. The company does trade similarly to McDonald’s on a P/E basis, at 17x earnings, but we see the company’s growth story as limited at best. Qdoba is a small part of earnings, and the company as a whole is expected to see a negative EPS decline of 4% for this year and only 4% growth in 2013.

Competing for McDonald’s share of the coffee and breakfast market is Dunkin Brands Group (NASDAQ: DNKN). The company sales coffee based beverages, baked goods, and other breakfast sandwich foods. McDonald’s refit its menu to offer various coffee drinks, including frappes. Dunkin plans to continue its westward expansion and possibly put more pressure on McDonald’s and its coffee shop peers. As noted elsewhere, Dunkin has impressive growth prospects, and trades at a trailing P/E of 80. Yet, the company appears underappreciated based on future growth prospects, as it trades at a forward P/E of 20. Also worth noting, besides Dunkin’s expected growth, is that they pay a dividend that yields almost 2%.

McDonald’s has caught the attention of various top fund managers, notably Ken Fisher, who overtook Jim Simons, as the top fund owner by shares in 2Q, both owned over 5 million shares. Meanwhile, Arrowstreet Capital and Diamond Hill Capital were also increasing their stakes.

Despite the fact that McDonald’s is one of the Dow’s three biggest losers, we believe the company a solid investment opportunity. With its recent price underperformance, McDonald’s is now the cheapest of all the burger chains from a valuation standpoint. While the other major burger peers trade in a wide range of values, with some being over 100x, McDonald’s trades at 17x and is also one of the more stable fast food stocks with a beta of 0.4. The company also recently announced a 10% increase in its quarterly dividend and pays a dividend that yields 3.5%.

 

 

 


This article is written by Marshall Hargrave and edited by Jake Mann. They don't own shares in any of the stocks mentioned in this article. The Motley Fool owns shares of McDonald's. Motley Fool newsletter services recommend Burger King Worldwide, Jack in the Box, 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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