Are the Golden Arches Falling?

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

The king of the fast-food industry recently released disappointing second-quarter financial results, confirming that the remainder of 2013 is likely to be unsatisfactory. Investors are now left with the question of what that news means to the entire industry and their money.

What Happened

On July 22, McDonald’s (NYSE: MCD) reported second-quarter financial results. Earnings of $1.38 per share came in $0.03 below the expected mark of $1.41, while revenue fell just short of the $7.1 billion expected, at $7.08 billion.

McDonald’s projects global same-restaurant sales in July to be relatively flat. The company’s CEO Don Thompson commented, “Based on recent sales trends, our results for the remainder of the year are expected to remain challenged.” The disappointment on the numbers side of things, as well as the downbeat forecast for the remainder of the year, combined to send the stock tumbling nearly 3% the next day.

Digging Deeper 

The report included second-quarter same-restaurant sales in the United States increasing 1%. McDonald’s blamed its uninspiring domestic results on smaller U.S. rivals, namely Wendy’s (NASDAQ: WEN) and Burger King (NYSE: BKW), debuting attention-grabbing products and limited-time offers.

Most prominently, Wendy’s Pretzel Bacon Cheeseburger is set to be the chain’s best-selling new product in at least a decade. While McDonalds’ did say its new line of Quarter Pounder hamburgers performed well, this comes after it pulled lackluster items such as premium Angus burgers and its Fruit & Walnut salad from its menu. Wendy’s, an entirely domestic company, is expected to report a 1.1% gain in second-quarter sales when it reports in August.

On the European front, same-restaurant sales were down 0.1% for McDonald’s, the third consecutive quarter of declines in the region. A deterioration in the European market does not appear to be a company specific trend, as in the first quarter, revenue generated from Burger King’s Europe, Middle East, and Africa segment dropped nearly 10%.

A decline was also experienced in the Asia/Pacific, Middle East and Africa (APMEA) region for McDonald’s, with sales falling 0.3%.

Yum! Brands (NYSE: YUM) also recently reported weakness stemming from the Asian region, when it posted sales at established restaurants in China dropping 10% in June, up from a drop of 19% in May. Much of this decline can be accredited to fears of the avian flu. The disease is believed to be passed on by live poultry, and with chicken being KFC's cornerstone product, fears that KFC's products might contain the disease have driven down sales in the country.  

How to Capitalize

In its report, McDonald's executives stated that it continues to gain share in the "informal eating out" category. While McDonald’s has long been the leader in this market, Yum! Brands is rapidly gaining in this category in China, where 48% of the company’s business is concentrated. Despite the recent problems Yum! Brands has had in the country, the ongoing expansion in Chinese incomes should fuel growth for this company in the future.

On the American front, Wendy’s has recently been the major winner in the race to gain market share. Rumors are swirling that the Pretzel Bacon Cheeseburger could become a permanent menu item, which could hurt Burger King and McDonald’s. Continued innovation from Wendy’s could spark growth for the company.

Burger King has also recently unveiled a series of limited-time products, which should fuel strong performance when the company reports in August. However, the company will have to continually innovate to sustain its market share, something in the past the company has failed to do.

Burger King will also have to adjust to softening conditions internationally. However, the company has continually displayed the ability to expand, increasing its overall store count by nearly 750 between 2010 and 2012. Sustained growth in its store count could offset poor same-restaurant growth numbers in weak markets.

For McDonald’s, the company’s superior marketing and innovation capabilities should allow the company to maintain its leadership position in the industry. While the European and APMEA segments remain weak, a recovering Europe and strengthening Chinese consumer should make for a stronger 2014.

The Foolish Bottom Line

A challenging rest of 2013 awaits McDonald’s. After the company fell short of numerical expectations, a gloomy forecast followed, sending the stock tumbling.

A primary cause of the weakness included stiff competition from Burger King and Wendy’s, both of which launched successful products during the quarter, a feat which McDonald’s failed to accomplish.

Digging deeper into the report and supplementary data reveals a marginally strengthening US market, in addition to weakening European and Asian markets.

Looking forward, investors should track the sustained lag the Avian flu has on Yum! Brands; improvement in economic conditions in Europe; and which companies innovate and are able to launch successful new products in coming quarters.

All in all, while McDonald’s results were disappointing, the pullback may have presented an attractive entry point for long-term investors in search of a stable and solid company.

Ryan Guenette owns shares of McDonald's. 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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