Don’t Panic Over Low Sales At McDonald’s

McDonald’s Corporation (NYSE:MCD) dipped slightly on higher than normal volume after the restaurant- which had topped our rankings of the most popular restaurant stocks among hedge funds at the end of the second quarter- announced that revenue from its portfolio of restaurants open at least 13 months dropped 1.8%. Sales were down in the U.S., in Europe (which is actually the source of about 40% of the company’s revenue) and in emerging markets. This news comes after McDonald’s 10-Q for the third quarter showed that total sales had been about flat compared to the third quarter of 2011, with slightly higher franchise revenue being offset by worse numbers at locations that the company operates. Net income was lower in the first three quarters of 2012 than in the same period in the previous year, but buybacks had powered a very small increase in EPS.

McDonald’s Corporation is now down 14% so far this year, even with the market rising. While its growth has been negative, and future prospects don’t look particularly good with higher-end quick service restaurants picking off some of its U.S. business, the stock remains an attractive value play. The trailing P/E of 16 and dividend yield of 3.5% are good metrics, and on a statistical basis McDonald’s (as one might expect) has little exposure to the broader economy with a beta of 0.3. Analyst expectations are for very low growth next year- likely resulting from flat net income and some buybacks- bringing the forward P/E to 15.

Ken Fisher - FISHER ASSET MANAGEMENT

Among the investors who liked McDonald’s Corporation during the second quarter of the year was billionaire Ken Fisher, whose Fisher Asset Management increased its position to 5.4 million shares (see more stock picks from Fisher Asset Management). Renaissance Technologies, whose success since inception has made founder Jim Simons a billionaire as well, also bought the stock during the quarter and closed June with 5.2 million shares in its portfolio (find more stocks that Renaissance Technologies liked).

McDonald’s closest peers are Burger King Worldwide Inc (NYSE:BKW) and Yum! Brands, Inc. (NYSE:YUM). These stocks trade at considerable premiums to McDonalds, even though that company would generally be regarded as the market leader: Burger King trades at 22 times forward earnings estimates, while Yum’s trailing and forward multiples are both about 20. Burger King’s sales and earnings numbers have not been good either, and so we think that we’d certainly rather own McDonald’s. Yum looks more attractive, reporting growth in both top and bottom lines as that company’s strategy of moving heavily into China continues to pay off. However, we’re not sure that exposure is going to be such a strong point going forward. We might look at the stock further, and it probably isn’t a good short candidate, but McDonalds does seem to be a better value.

Even more highly valued than those peers on a forward earnings basis are Chipotle Mexican Grill, Inc. (NYSE:CMG) and Panera Bread Co (NASDAQ:PNRA) which are trading at 24-25 times their expected earnings for 2013. Both of these companies are experiencing solid growth, obviously, which explains why even this pricing is lower than their trailing P/E (30, in both cases). Revenue growth rates at these quick service restaurants versus a year earlier were remarkably similar, with Panera’s 27% increase in net income being only somewhat higher than Chipotle’s 20% growth rate. We’d expect that growth rate to slow as those companies get closer to saturation, and certainly their premium to McDonald’s is even higher than that of Burger King or Yum.

McDonald’s still has a very secure place in the restaurant market, and compared to its peers it is priced for considerably lower growth rates going forward. While it’s possible that the company could end up posting further disappointing results, these initial numbers aren’t worrisome. One final note: the last month that McDonald’s experienced a similar decline was in 2003. The stock price was up 50% that year and an additional 29% in 2004. We don’t expect that kind of results, but history demonstrates that a month of lower sales isn’t necessarily a sell signal.

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