McDonald’s: Tough Road Ahead
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McDonald’s (NYSE: MCD) has by and large maintained its reputation as the most consistent company in its sector with a growth of ~23% in annual earnings per share in the last ten years. It has been one of the most trusted companies by investors. But the company is facing some headwinds of late, and its stock price has declined 11.06% YTD as compared to the S&P 500’s 7.25% gains. In contrast, other restaurant companies with high exposure to domestic consumers have done well. We believe it will be a tough road ahead for the company going forward. Here are some of the key concerns.
Stiff Competition from Local and International Brands
McDonald’s is facing tough competition from its local and global peers and has underperformed the broader markets and its peers year to date. The following chart compares the year-to-date stock price movements of McDonald’s versus its peer group companies like YUM! Brands (NYSE: YUM), Chipotle Mexican Grill (NYSE: CMG) and Buffalo Wild Wings (NASDAQ: BWLD).
Source: Google Finance
McDonald’s, with an 11.06% decline, has significantly underperformed its peers YUM Brands, Chipotle Mexican Grill, and Buffalo Wild Wings, which have gained 8.96%, 12.53% and 25.92% respectively.
On the domestic front, changes in dietary preferences and obesity litigations are some of the major concerns for McDonalds, while on the global front competition from other leading chains is a big concern. A lot of leading restaurant companies like Subway, Burger King, Buffalo Wild Wings, and Wendy’s are now realizing the huge growth potential in emerging markets and have increased their international focus, which translates into increased competition for McDonald’s.
Denny’s has recently announced plans to set up 50 units in India. Starbucks and Dunkin' Brands have also announced plans to enter the country. Subway recently surpassed McDonald’s in total number of restaurants worldwide. Burger King, the world’s second largest hamburger company, recently announced its plans for setting up 1,000 restaurants in China in the coming five years. These developments put McDonald’s in a tough position.
Disappointing Sales Results
McDonald’s missed the consensus same store sales (SSS) estimates for the second consecutive month in May. May results were disappointing, with SSS of 3.3% globally as compared to consensus sales of 4.9% and the company posted below than expected SSS in each region:
- U.S. +4.4% compared to consensus of 5.3%.
- Europe: +2.9% compared to consensus of 5.1%
- APMEA: -1.7% below consensus of 3.2%
APMEA (Asia Pacific/Middle East/Africa), which constituted around ~17% of profits last year, was the biggest surprise with Japan and China posting negative SSS. Japan (-11% SSS) accounted for about one point of the overall SSS miss. China also slowed considerably (likely down low-single digits vs. up high single digits YTD through April).
Slowing Economic Growth & Recession in Europe
Slowing economic growth and recession in Europe has weakened consumer spending in Europe. McDonald’s derives ~37% of its profits from Europe, and hence the European slowdown is a big negative for the company. In addition to slowing sales, McDonald is also facing forex headwinds as a declining Euro is reducing its profits.
McDonald's is trading at a forward PE of 14.60x, which is not excessively high, but more than some of the companies seeing better trends. For example, Darden Restaurants (NYSE: DRI) is expected to grow its top line and EPS by 7.50% and 13% respectively from the current fiscal year to the next. This is better than McDonald's, which expects rates of 5.50% and 10%. Still, Darden is trading at a forward PE of just 11.35x. Clearly there is more upside potential in some of the other restaurant names than McDonald's. I would prefer to be on the sidelines and avoid this stock.
TheAnalystBlog has no positions in the stocks mentioned above. The Motley Fool owns shares of Buffalo Wild Wings, Chipotle Mexican Grill, Darden Restaurants, and McDonald's. Motley Fool newsletter services recommend Buffalo Wild Wings, Chipotle Mexican Grill, McDonald's, and Yum! Brands. 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.