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Even McDonald's Can't Beat the Slowdown
07/24/2012 5:01 pm EST
But even across-the-board disappointment doesn't mean you should short the Golden Arches just yet, writes MoneyShow's Jim Jubak, also of Jubak's Picks.
That was one depressing conference call.
It wasn't because the results McDonald’s (MCD) announced yesterday were so bad, or because the company slashed guidance. McDonald’s did miss Wall Street earnings estimates by 6 cents a share, but that was the result of a strong dollar that took 7 cents a share out of earnings.
No, what was really depressing was the results demonstrated that not even McDonald’s can escape the effects of the global economic slowdown—and that the company’s assessment of the global economy was so negative looking forward.
Normally, new CEO Don Thompson said, the company might see one or two of its top ten markets struggling. Never, he noted, has McDonald’s seen an across the board slowdown. In addition, the company said that it is starting to see signs that the length of the current economic slowdown is changing consumer behavior.
In this very challenging environment, the company continues to do what it has always done, but has also added new wrinkles. In the what it’s always done category, McDonald’s will refurbish—the company calls it re-imaging—2,400 restaurants in 2012, as well as opening 1,300 new restaurants in emerging markets.
In the new wrinkles category, McDonald’s launched a “Loose Change Menu” with seven menu favorites—a small order of fries or a ten-piece chicken McBites—selling for less than $2.50.
Started in March, the idea is to offer low-priced items—items that you can buy with the change you find in your couch, according to the company’s formulation (can I get one of those sofas?)—that will get customers into the store and then hope that they’ll upgrade to items such as a Cheeseburger combo or a value family dinner box. (The company reports that the menu is working.)
The problem, though, is that the tough economy is cutting into the company’s operating margins. Labor and commodity costs are up—but McDonald’s doesn’t feel able to pass through all those higher costs to consumers. And the margins on the “Loose Change” and “Value” menus aren’t as high as those on items such as a Mighty Angus burger.
Margins at company-operated stores fell to 18.2% globally, from 19% in the second quarter of 2011. For the company as a whole, operating margins fell slightly to 31.2%, from the 31.7% of the second quarter of 2011.
And McDonald’s doesn’t look likely to make up for those falling margins on volume. Revenue climbed less than 1% in the quarter, and same-store sales grew by just 3.7%.
So why own this stock?
At current prices, the shares pay a 3.15% dividend, making McDonald’s a relatively low-risk/high-yield place to park your money at a time when the ten-year US Treasury is yielding just 1.42%.
And although McDonald’s isn’t going to be able to escape the bad times in the global economy, the company is picking up share against competitors, and is sufficiently profitable to franchisees that they’re willing to invest in refreshing their stores and follow the company’s lead on unified positioning, such as with the McDonald’s Value Menu.
It does indeed look like McDonald’s may miss its target of 6% to 7% growth (on a constant currency basis) in operating income in 2012, thanks to the global economic slowdown.
But McDonald’s is very reasonably priced at 16.7 times earnings—competitor Yum! Brands (YUM) sells at a trailing 12-month price-to-earnings ratio of 20.9—for a company that went into this slowdown as the leader of the quick-serve segment, and looks like it will come out of this downturn—whenever that happens—with an even bigger lead on the competition.
McDonald’s is a member of my Jubak’s Picks portfolio, where I have a target price of $109 by May 2013. As of July 23, I’m leaving my target price at that level.
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