Is McDonald's Still A Hot Buy?
Maxwell is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
It seems the public’s taste for fast food burgers is not waning despite the continuing economic recovery, as McDonald’s (NYSE: MCD) and Wendy’s (NASDAQ: WEN) recently reported sales and earnings that were up. However, both chains failed to meet analyst expectations, and their own expectations. This mixed bag of results do not present clear indicators to me that either of them are unworthy investments.
McDonald’s reported same store sales growth in April was 3.3% in the U.S., 3.5% in Europe, and 1.1% in Asia, Africa and the Middle East. These numbers reflect sales at restaurants that have been open for at least 13 months.
While there were increases, some of them weren’t as much as anticipated. In fact, the company missed its own estimate of 4%. Wall Street analysts were looking for 4.3%.
One point that I think that it is very interesting is that McDonald’s beat its own estimates and those of analysts for Europe, where the economy is extremely shaky.
I think that the company failing to reach the 4.3% targeted by analysts does not reflect its strength. McDonald’s is one of those companies’ that I think analysts often overshoot when it comes to earnings and sales.
McDonald’s has banked on the success of its extra value menu, which includes a 20-piece Chicken McNugget item. Also being heavily promoted are several beverage items that offer something different from regular cola products, such as smoothies. It has even added oatmeal as a choice to its breakfast menu. To taunt grown ups, it offers an Angus burger and a premium chicken sandwich.
To my surprise, diners in Germany and the U.K. have become quite the fans of the Monopoly game that McDonalds offers, which features free food and larger prizes like cars. The company said that this fueled the results for the month there.
Wendy’s released its 2012 first quarter earnings report around the same time as McDonald’s sales growth report. It showed that revenues totaled $593.2 million compared to $582.5 million for the first quarter of 2011. Same-store sales increased 0.8% in the first quarter of 2012, marking the fourth consecutive quarter of positive same-store sales. Franchise same-store sales in North America increased 0.7% during the quarter, according to the company.
The financial picture of Wendy’s is bleaker than that of McDonald’s, however. It reported that its operating margin was 11.8% in the first quarter of 2012 compared to 13.4% in the first quarter of 2011. It blamed the margin decline on higher commodity costs, especially those for “fresh beef.” It also said that its sales and margins during the first quarter were negatively affected by the promotion of the “W” cheeseburger.
This doesn’t sound like a very good excuse to me. The “W” cheeseburger was hailed as the next best thing in the commercials I saw over and over again. I’m no food critic, but I do listen and I didn’t hear too many positive comments about this burger. If this was supposed to be such a big deal when it comes to burgers, and it failed, there is a problem. This is especially true if its sales drive down margins.
Now let’s look at some of the fundamentals of these companies and how they stack up to the industry. McDonald’s has a strong gross margin of about 40%, which is higher than the industry’s gross margin of roughly 30%. Also noteworthy is the fact that McDonald’s gross margin is even higher than that of Yum! Brands (NYSE: YUM), whose margin is about 27%. Considering Yum! is often referred to as one of the industry’s darlings, the fact that McDonald’s gross margin is higher is impressive. Yum! operates KFC, Pizza Hut and Taco Bell.
McDonald’s has the largest market capitalization of all three at roughly $95 billion. Yum! is next at $33 billion, and Wendy’s is $1.8 billion. All of them pay dividends, but McDonald’s pays the most, yielding 2.9%. The yield for Yum! and Wendy’s is 1.6%.
Earnings per share for Yum! are $3.16. They are $5.35 for Wendy’s and $.02 for McDonald’s.
To the credit of these chains, they are expanding their menus to include food items that go beyond the typical greasy burger and fries. Being able to offer these items at prices that are affordable will be key to them being able to improve their financials. One of the biggest challenges for Wendy’s and McDonald’s is the increased costs of beef. I like the idea that they are adding more chicken items to their menus to offer customers a choice different from the more expensive beef products.
These companies must also contend with other competitors in the industry, such as Chipotle and Panera. Even with the weakening economy, these businesses have thrived. Furthermore, they have managed to continue to attract diners even though their menu items are priced higher.
McDonald’s and Wendy’s will have to continue to take steps to increase their EPS growth and revenue growth. This will weigh heavily on them being able to increase their net incomes and expand their profit margins.
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