McDonald's Deserves a Place in Your Portfolio

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

By now even the freshman investors charting Wall Street for the first time have heard about the ‘disappointment’ that McDonald’s (NYSE: MCD) second quarter results have caused. It is true the numbers do look modest and short of expectations.

But, when analyzing a company that runs over 34,000 restaurants in 120+ countries and feeds 69 million people every day, there cannot be hasty conclusions. So, let us examine the odds, take a re-look at the numbers, and finally figure if McDonald’s dividends are at risk.

The odds

The biggest challenge that McDonald’s is facing comes from the uncertain economic conditions in most parts of the world. The company in its recent earnings call has stated that out of its 11 big markets, 7 are contracting and competitive pressures are mounting.

Challenges at home

The going is tough in the U.S., where McDonald’s has over 14,000 restaurants. Total food service sales were off 1.2% in June, the biggest drop since February 2008. According to Crest data, the informal eating out industry, which is mostly comprises quick service restaurants, is expected to be down by 50 basis points, 0.5%, this year.

Pressures are increasing from Wendy’s (NASDAQ: WEN) and Burger King (NYSE: BKW). In the second quarter, Wendy’s clocked 0.4% comps growth in North America while Burger King posted a 0.5% decline in this market. Both chains will be more aggressive in the second half as they heavily promote their value menus, add new items, and renovate stores.

Wendy’s has created a lot of positive ripples in the market with its flat bread grilled chicken sandwich that it introduced in April. It has fortified its $0.99 price point-menu offerings and will shortly launch its Pretzel Bacon Cheeseburger, which is being hailed as the chain’s most exciting launch in over a decade. The stock is up over 51% year-to-date.

Meanwhile, Burger King is looming with its new lattes, Rib Sandwich, and Barbecued Chicken Salad. It also did a good job with its Summer Barbeque menu, the $1.29 Whopper Jr, and $0.50 ice cream cones in the second quarter. The company is on a growth path and the optimism shows in the 13% share price increase through the year.

Challenges away from home

Both Europe and Asia Pacific, Middle East and Africa (APMEA) segments are facing uncertain market conditions. In Europe, youth unemployment rates are at 26% and 57% in France and Spain respectively. Germany is reporting negative GDP growth while things remain tight in Portugal and Ireland.

Turning to Asia, the three big markets of China, Japan, and Australia are all down. Recent statistics suggest the growth in China has been slower than expected. The break out of the bird flu epidemic had compounded the trouble, although it is ebbing now.

The results

Now let us take a re-look at McDonald’s second quarter results. The company increased its revenue by 2.4% to $7.08 billion, just missing expectations of $7.1 billion. It leveraged this increase to grow its profits by 3.7% to $1.4 billion or $1.38 per share. Analysts had expected $1.40 per share.

Looking at same-store sales, the system-wide 1% growth was ahead of the analysts’ projections of 0.08%. While the U.S. comparable store growth of 1% lagged the 1.5% expected, we need to consider that in addition to tough market conditions, the company was facing huge comparisons from last year when it was promoting its 20-piece Chicken McNuggets. It is noteworthy that McDonald’s managed to maintain its last year’s operating income and grew its market share.

 Both Europe and APMEA segments grew profits despite a drop in comp sales by 10 basis points and 30 basis points respectively. In Europe operating income was up 5% and in APMEA it was up by 3%.

The strategies

The key takeaway for investors is that the numbers are still up, on the whole defying odds. McDonald’s has some solid strategies to keep its growth trajectory intact. In the U.S., the value menu is still a focus area as the company tries to win over customers by consistently offering everyday value as against aggressive discounting campaigns.

Overall McDonald’s has four areas of emphasis – chicken, breakfast, beverages, and beef. Accordingly, we have the Chicken McWraps, Egg White Delight, Blueberry Pomegranate smoothies, and the Quarter Pounders that are all looking good.

Key strategies are taking form and shape in overseas markets as well. So in the U.K. we have the new smoothies, in Russia the growing number of Big Mac options and in France the new item additions to the popular Casse-Croute entrée and drink combo. Meanwhile, in Japan there are limited time offerings like Chicken Teritama and sharing options like Mega Potato. And in China there are the ongoing efforts to bring more menu options in line with local tastes.

Concurrently, the restaurant modernization program is going on in full swing. McDonald’s is targeting to renovate the exteriors for 50% and interiors for 60% of its global locations. In the US, about 10% of its restaurants will be renovated this year.

The inference

McDonald’s has survived many ups and downs in the past and has always come out stronger and the current times will not be an exception. The company is holding up despite the numerous challenges that it is facing and has good strategies in the form of its value platforms, menu innovations, store modernizations, etc. Investors can stay assured the attractive dividend yield of 3.1%that they receive from the Golden Arches is well protected.

Eshna De has no position in any stocks mentioned. 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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