Will the King Be Dethroned?

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

Unfortunately, 2012 wasn’t a great year for one of the biggest food brands in the world. In October 2012, McDonald’s (NYSE: MCD) quarterly sales didn’t meet its expectations for the second time in a row. The last time this thing happened was back in 2003. While investors were expecting EPS of $1.45, McDonald’s earnings fell to $1.43 per share in 3Q 2012. As a result, company’s shares fell to $89.71. Now, the question which comes in everyone’s mind is that what will happen in 2013? 

Key Sales Figure Going Down

Two months ago, McDonald’s announced that a major sales figure had fallen for the very first time in almost a decade. According to the company, the “figure” is of foremost importance to the company as it reflects the sales at restaurants open at least a year. In U.S. and Europe, it fell by 2.2%, while in Asia, Middle East and Africa, it fell by 2.4%. In case of Canada, this sales figure was positive.

(Source: www.huffingtonpost.com)

More Competition in the Market

Tough competition in the restaurant industry is the major reason behind McDonald’s recent downfall. Competitors like Burger King and Wendy’s are grabbing much of McDonald’s share with new menus and aggressive ad campaigns. Moreover, better quality food at restaurants like Chipotle Mexican Grill and Panera Bread is driving customers away from McDonald’s.

One Dollar Menu

After the dismal failure of “Extra Value Menu,” the company is shifting to its decade old “one dollar menu” in the U.S. Moreover, as opposed to the old one dollar menu, the new menu isn’t that attractive. Thanks to high ingredients’ costs, the new one dollar menu doesn’t even include small fries.

New Plans across the Globe

McDonald’s gets 40% of its business from Europe. In 2013, the company plans on giving different meals at different price ranges in the European countries. The company had a good year (2012) in U.K but it didn’t do that well in Asia. The company has plans of differentiating itself in the Asian market with menus customized to personal tastes.

Valuation

McDonald’s is currently trading at a forward P/E (1yr) of 15.96x and is yielding a dividend of 3.40%. Its PEG is 2.02 and has a mean recommendation of 2.3 on the sell side. Incorporating MCD’s dividend yield in its PEG, we get to a PEGY of 1.45. Moreover, its mean target price from the sell side is $97.22. Therefore, it has an upside potential of 6.5%.

Yum! (NYSE: YUM) is yielding a dividend of 2% on its stock, has a PEG of 1.49 and a mean recommendation of 2.2 on the sell side. Its PEGY comes out to be 1.29 and has a mean target price of $74.62 on the sell side. Therefore, it has upside potential of 14.5%.  At the moment, YUM’s PEGY is lowest in the restaurant industry, which shows that it’s probably one of the best buys in the industry. Moreover, it has a staggering 74% return on equity. However, its payout ratio isn’t that much. Rather than rewarding its shareholders, the company has been keen on investing its income back into the business.

Wendy’s (NASDAQ: WEN) is trading at a forward P/E (1yr) of 25.52x and has a PEG of 2.70. According to the sell side estimates, its target price is $5.16. Therefore, at this moment, it’s undervalued by 1.1%. When compared to YUM, it’s yielding a higher dividend of 3.10%. However, its PEGY of 2.04 makes it the most expensive stock among all of them. Moreover, a ROE of 0.2% shows that the company is financing its major chunk of dividends through debts. Furthermore, a mean recommendation of 2.9 clearly shows that it isn’t as attractive as others in the industry.

McDonald’s other major competitor i.e. Chipotle Mexican Grill is trading at a forward P/E (1yr) of 28.70x. Its ROE is 24% and has a PEG of 1.61. CMG’s PEG clearly depicts that it’s overvalued as compared to MCD, YUM and WEN. A mean recommendation of 2.6 also tells the same story.

MCD’s Earnings Preview

McDonald’s will be releasing its earnings for 4Q 2012 on of January 23. Once again, investors would be looking at the same key sales figures that would depict company’s net sales in the newly opened and closed restaurants. In 4Q 2012, the figure is expected to increase after a dip in 3Q 2012. Investors are expecting MCD to yield an EPS of $1.33 on an expected revenue of $6.89 billion.

Conclusion

McDonald’s hasn’t been doing that well lately but the company has always been keen on rewarding its shareholders, a dividend yield of 3.40% is a testimony to this. Moreover, the average dividend increase during the last 5 years has been 14%. Though the company is facing a declining sales trend, it’s still keen on increasing its dividends for its shareholders. A 10% increase in its dividend per share during 4Q 2012 clearly shows its objective. But the matter of fact is that is McDonald’s sacrificing its growth by giving such high dividends? The answer might well be “no.”

2012 hasn’t been a great year for the restaurant industry and 2013 won’t be that different either. Weak employment, high health care costs and high commodity prices will keep people away from spending more in the industry. Hence, rewarding more today is not such a bad idea after all. The company can always make up for this later (from 2014 onwards), when the restaurant industry starts to rise again. In short, McDonald’s will keep on maintaining its high dividends but won’t see much capital appreciation during 2013. In short, it isn’t a good buy for the short run but it’s definitely a great buy for the long run.


Vamosrafa7 has no position in any stocks mentioned. The Motley Fool recommends 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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