This Stock Is Undercooked Ahead of Earnings, But Digestible
Richard is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Over the past couple years, the steady growth of fast food giant McDonald's (NYSE: MCD) has been nothing short of remarkable. And this is something that is expected to continue at a steady pace. But the company is coming off a subpar Q3 and investors have grown concerned about decreased margins.
Then again, over the past 6 months, if you placed orders for restaurant stocks such as Chipotle Mexican Grill and Yum! Brands, you’d have cause to send them back -- they were undercooked. The entire service sector was a disappointment. Still, this is no excuse for McDonald’s – not when it carries a P/E of 17. With its Q4 report due out Wednesday, investors are expecting gourmet results. But at what cost?
Q3 Wasn’t Crisp, But It Wasn’t Burnt Either
The Street overreacted to McDonald’s third quarter report. The company posted net income of $1.46 billion, or $1.43 per share on revenues of $7.15 billion. The miss on EPS was a disappointment as analysts projected $1.47 per share. Too, the 3% decline in net income was the second consecutive quarter of profit declines.
But revenues were impressive, exceeding estimates of $6.94 billion with sales reaching $7.15 billion. Nonetheless, the focus was on the fact that it represented a year-over-year decline of 20 basis points – ending the company’s streak of four consecutive quarters of revenue growth. But as noted, McDonald’s was not alone.
Take Chipotle (NYSE: CMG) for instance. In its third quarter, the company reported net income of $72.3 million, or $2.27 per share on revenues of $700.5 million. Not only did Chipotle miss EPS estimates of $2.33 but revenue also fell $6.6 million short of projections. Then again, despite the top and bottom line miss, both earnings and revenue grew by 20% and 18%, respectively.
Though the company is outpacing McDonald’s in terms of growth, the Street had priced the stock higher and expected more. Unfortunately for Chipotle, it has begun to suffer from the growth of Yum! Brands (NYSE: YUM), which owns the popular Taco Bell chain.
Also hurting Chipotle is that famous short seller David Einhorn has placed some huge bets against it, citing Taco Bell’s Cantina Bell unit, which is designed to go up against the Fresh Mex found at Chipotle. So far it’s working. Since Yum! launched Cantina Bell unit, Chipotle has lost 33% of its value.
So Einhorn seems to know what he’s talking about as Chipotle’s margins have come under pressure from Yum! Although McDonald’s Q3 wasn’t as daunting, it wasn’t flawless either. Operating income was a little soft – showing a 4% decline to $2.29 billion. Likewise, due to increased competition, operating margins registered at 32%, shedding 140 basis points.
However, unlike Chipotle, McDonald’s same-store-sales (comps) were decent, with U.S. restaurants producing 1.2% growth in comps. Impressively, Despite the ongoing fiscal concerns abroad, the company enjoyed same-store-sales growth in Europe of 1.8%. This means unlike Chipotle, McDonald’s has found ways to grow despite stiff competition.
Expectations for Q4
Analysts aren’t expecting much sequential improvement and flat year-over-year performance. The Street is expecting $1.33 in earnings per share on revenues of $6.89 billion. Likewise, these estimates have remained steady over the past two months. For the full year, analysts are expecting $5.31 per share earnings on revenue of $27.50 billion.
This would represent an increase in 4 cents per share year-over-year, with a light revenue decline. Despite this less than rosy outlook, management remains optimistic – with good reason. The company proved that it is not immune to the global economic slowdown.
McDonald’s will overcome this near-term turbulence and regain its dominant form as it has demonstrated over the past decade. For that matter, there are very few companies that have performed as well as McDonald’s in any category.
This includes growing average annual sales by 6% while more than doubling its operating margins. Despite its track record, the company rarely gets mentioned among some of the best run operations on the market.
The company is unparalleled when it comes to strategic pricing and outside the box thinking. With the stock having suffered a pullback of late, I would be a buyer here ahead of earnings. The company still has a strong balance sheet and margins will improve. In the meantime, investors with patience will enjoy a stable brand that offers one of the best dividend yields on the market at 2.9%
rsaintvilus has no position in any stocks mentioned. The Motley Fool recommends Chipotle Mexican Grill and McDonald's. The Motley Fool owns shares of Chipotle Mexican Grill 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!