The markets have been fixated on McDonald’s (NYSE: MCD) global comp miss of 3.3%. This fell short of management guidance of 4%, vs. 2011 results of 6%, and consensus estimates of 4.8%. We suspect that the miss was due to weak US sales in the last ten days of the month. Overall April numbers were on the light side, with weak Japan comp sales of negative 3.6% and slower-than-expected US comp sales of 3.3%. However, when results are viewed from a fiscal year perspective, we see no reason why MCD won’t be able to meet its earnings guidance since the 1% global comp change q-o-q is only equivalent to approximately 2% of annual EPS and since margins are getting a breather with a drop in dairy, coffee, and produce costs. In spite of potential macro headwinds, we continue to believe that MCD is a top notch operator in the global quick service restaurant (QSR) market, and think it is well-positioned to outperform its peers.
Quarter performance breakdown by region:
US: Sales were driven by new menu additions including Chicken McBites, beverages i.e., frappes, and Angus burgers. The “Extra Value” menu that the company rolled out in late March contributed modestly to sales, but we see the promotions in April as the main driver for recent numbers. We think margins may get a lift if MCD shifts the menu mix to higher margin offerings like snack wraps over the dollar menu items.
Europe: We were worried about European performance in light of the less than ideal macro factors clouding the region, but MCD reported a solid 3.5% comp that beat consensus estimates of 3.2%. The Monopoly game marketing initiative in the UK and Germany and restaurant unit image remodeling drove the beat but guest counts remains tenuous with YTD traffic in France and Germany being negative. This though, was offset by good performance in the UK and Russia. It’s worth noting that the region’s performance is down significantly from 6.9% in March. Looking forward we do not expect this region to be a growth engine for MCD.
Asia Pacific Middle East and Africa (APMEA): The region same store sales (SSS) of 1.1% was down from 6.4% in March. As expected, China SSS numbers slowed in March and April. However, unexpectedly Japan was down quite a bit, posting negative 3.6% SSS versus 6% in March. Australia was not a strong contributor either. We anticipate the profitability mix will continue to lean towards these faster growing regions over time.
If the past is any indicator of future performance, MCD has been remarkably resilient even with a challenging macro environment. In 2008, MCD’s resilience was proven as it held the status of being one of two companies of the Dow 30 to see any appreciation at all, and in 2011, MCD shares were up 31% versus a flat S&P 500. YTD though, MCD is down 4%, QSR is up 4%, and the S&P 500 is up 9%. In terms of valuation, QSR is trading at ~18.0x CY 2013 EPS, with MCD currently trading at ~15.0x CY 2013 EPS. We think this leaves room for upside compared to YUM! Brands (NYSE: YUM), which is trading at ~19.5x CY2013 EPS and to its own average since 2006 of ~16.0x. YUM has been gaining momentum and there are high expectations for its China numbers. China alone accounts for ~45% of total system profits. We think it is the company’s prospects of double-digit earnings growth as it expands into additional emerging economies that explains the premium it trades at. On a P/E basis, we think MCD could trade up to 17.0x at the very least. Looking at an EV/EBITDA multiple, MCD also looks cheap, trading at ~10.5x 2012 estimates versus QSR peers that trade at ~9.5x. We expect shares to progress higher based on its dominant leadership position in the QSR industry and restaurant industry as a whole as it continues to gain market share internationally. Stable SSS numbers, unit growth abroad, and the company’s remodeling initiative should support a slight multiple expansion.
Is the slowing US sales in April a trend that will spillover to the next quarter? Our feeling is that it can be attributed to intensifying competitive pressures i.e., new Burger King menu and a weakening US consumer but that MCD will be able to hold its own and offset these areas by posting strong international numbers. Hedge fund managers that share our optimism on MCD include John Horseman, Charles Anderson, Peter Eichler, and David Winters. The company has returned $5-$6 billion annually to shareholders via dividends and share repurchase in the past couple of years, which is one of many reasons why we recommend MCD as a long-term conviction investment.
