The Sweet Taste of Disappointment

06/13/2012 4:26 pm EST


Jim Jubak

Founder and Editor,

A bad monthly report can knock otherwise strong stocks down enough pegs to create a buying opportunity, and that may be happening right now with McDonalds and a major competitor, writes MoneyShow’s Jim Jubak, also of Jubak’s Picks.

On June 8, disappointing news from McDonald’s (MCD) took down shares of…well, YUM! Brands (YUM). For the day, McDonald’s shares fell 0.07%, while shares of its major competitor tumbled 3.3%.

The drop came after McDonald’s announced disappointing same-store sales for May—with especially rough results from its Asia-Pacific, Middle East, and Africa unit.

Comparable-store sales in the United States climbed 4.4% in May—more than fine given evidence that the US economy is slowing. Sales in Europe increased by 2.9%—better than expected considering that much of Europe is in a near or actual recession. (Better than expected sales in the United Kingdom, Russia, and France offset weaker results from Germany.)

In the company’s Asia/Pacific, Middle East, and Africa unit, however, comparable-store sales fell by 1.7% in May—and that was worse than expected. (Analysts had been looking for 3.2% same-store sales growth in the region.)

The worst sales decline came in Japan, but sales in China also lagged expectations. Margins at company-operated restaurants in the region fell to 17.5% from 16.9%, as McDonald’s promoted its value menu to drive traffic to stores.

Companywide comparable-store sales grew by 3.1% in May. Systemwide sales grew by 1.2%, or 5.6% in constant currencies.

It’s actually perfectly reasonable that McDonald’s disappointing same-store sales numbers in Asia would hit YUM! Brands harder than they hit McDonald’s itself: Asia, specifically China, is a much bigger piece of the pie at YUM! than at McDonald’s.

McDonald’s aims to grow rapidly in China, but the company has just 1,500 restaurants in the country, against 4,600 for YUM! Brands’ Pizza Hut and KFC units. The company got 44% of 2011 sales from China and 50% of 2011 profits.

But let’s be clear: what we’re talking about here is “relative” disappointment off some tough to beat numbers. In the first quarter of 2012, for example, YUM! Brands showed 14% gains in comparable-store sales.

In the second quarter, Wall Street analysts are looking for comparable-store sales growth in the low double-digits for YUM! in China. That would decline to high single-digit comparable sales growth in the second half. That’s hardly a disaster.

McDonald’s also seems to be going through one of those occasional resets. According to the Wall Street consensus, earnings growth will dip to a 2.5% annual growth rate in the second quarter, before rebounding in the third quarter to 6.6% on the way to 6.2% earnings growth for all of 2012. The analyst consensus calls for 10.5% earnings growth in 2013.

The weakness in share prices that comes with a reset like that—in McDonald’s and in YUM! Brands—is a buying opportunity as long as you believe that the growth opportunities in front of these companies haven‘t changed radically.

McDonald’s shows a trailing 12-month return on invested capital of 20.6%. YUM’s for the trailing 12-months is 27%. With China, India, and the rest of the emerging world still representing opportunities for growth, those returns look reasonably safe for the future. In a world where ten-year Treasuries yield less than 2%, a company that can get better than 20% on its capital is very interesting to me indeed.

I’ve got a 12-month target price of $109 for McDonald’s in my Jubak’s Picks portfolio. YUM! Brands is, as of June 13, on my watch list.

Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund, may or may not now own positions in any stock mentioned in this post. The fund did own shares of Polypore International as of the end of September. For a full list of the stocks in the fund as of the end of September see the fund’s portfolio here.

  By clicking submit, you agree to our privacy policy & terms of service.

Related Articles on STOCKS