World’s largest hamburger chain, McDonald’s Corporation (NYSE:MCD) , reported a lower-than-expected profit during its second quarter. Weak sales in Europe and tough competition in the U.S. were the culprits behind the company’s dull performance.
As soon as the company released its earnings, its share price fell by almost 3% in just a few hours. With McDonald’s Corporation (NYSE:MCD) losing its global market share, two key questions arise: What is in store for the company going forward? And does this low price make McDonald’s a buy?
McDonald’s earnings
Global same-store sales were up 1%, in line with analysts’ expectations. However, U.S. comparable sales missed estimates by 0.5%.
For the third consecutive quarter, European same-store sales declined by 0.1%. In Asia/Pacific, Middle East and Africa (APMEA), sales were down by 0.3%. European sales were in line with the expectation but APMEA sales missed expectations by 1%.
Going forward
In the U.S., restaurants like Wendy’s and Burger King Worldwide Inc (NYSE:BKW) have given McDonald’s Corporation (NYSE:MCD) a tough time during the past few months. Due to global economic downturn, consumers have been hesitant in spending their hard earned money in the fast-food sector. As a result, McDonald’s has added more items in its dollar menu in the U.S. and has launched value-meals across the globe.
McDonald’s Corporation (NYSE:MCD) has plans of expanding its line of newly introduced quarter-pound hamburgers including bacon and habanero ranch burgers. Further, the company is removing Angus burgers and fruit & walnut salad from its menus. In the breakfast category, it has introduced an egg white version of McMuffin sandwich.
In the next quarter, analysts expect McDonald’s to earn $1.53 per share on total revenue of $7.43 billion. For the full year, analysts’ estimates stand at $5.66 on $28.40 billion revenue.
Valuation
McDonald’s is trading at a low forward P/E (1yr) of 15.79 and yields a dividend of 3.10%, making it one of the cheapest buys in the restaurant industry. It has a PEG of 2.04 and a PEGY of 1.5. McDonald’s PEGY is among the lowest in the industry, making it a lucrative buy.
McDonald’s high cash per share of $1.87 (2.4 times its current quarterly dividend) reflects company’s strong liquidity. Therefore, the company can easily grow its dividends in the future (just like it has done before).
According to the sell side, McDonald’s has a one-year price target of $106. This shows that it’s an undervalued stock and has an upside potential of 9%. Adding its dividend yield into this gives us a total return of 12%.
Competitors
McDonald’s biggest rival, Yum! Brands, Inc. (NYSE:YUM), didn’t do that well in the first half of 2013, amid poultry issues in China and an avian flu outbreak. However, the company’s June sales show that its earnings have finally started to show some improvements. Yum!’s premier brand, KFC, reported that sales at its Chinese restaurants declined by 13% in June, compared to 25% in May and 36% in April. This shows that the worst is behind the company and it’s finally heading in the right direction.
A mean recommendation of 2.3 on the sell side shows that Yum! Brands, Inc. (NYSE:YUM) is one of the top buys in the food industry at this stage. Using earnings multiples, I value Yum! Brands at $81. This shows that it’s also an undervalued stock, having an upside potential of 12%.
In an effort to lower its overhead costs, the American fast-food chain, Burger King Worldwide Inc (NYSE:BKW), is selling more restaurants to franchisees. During the past few months, the company’s new variety deals have given a tough competition to its rivals. New items like bacon sundaes have also shown a lot of promise. Plus, with Burger King expanding its home delivery services in the U.S., things look much better for the restaurant chain.
Burger King is trading at a forward P/E (1yr) of 21.40 and yields a dividend of 1.20%, which makes it far more expensive than McDonald’s. According to the sell side, Burger King has a one-year price target of $19.29, showing that it’s slightly overpriced. The bottom line is that though Burger King is doing well, its stock isn’t a very good investment.
Conclusion
McDonald’s introduction of new items on the dollar menu has seen a great amount of interest among the U.S. consumers. Late night breakfasts have also been among the top contributors of revenue in the region. Given the fact that the U.S. economy is gradually improving, the company is expected to do a lot better in the U.S. during the next quarter. Europe’s sluggish economic growth means that McDonald’s has to look somewhere else for profits. As the Russian market looks to be a great place for improving margins, McDonald’s decision of expanding itself over there seems to be bang on target.
McDonald’s hasn’t done that well in the recent past, but the fact is that it’s one of the top restaurants in the world. A super high ROE of 37% depicts that it’s still minting a lot of money for its shareholders. The global economic meltdown has been the core reason behind its lackluster quarter. With the global economy heading in the right direction, McDonald’s margins seem to be going nowhere but up. Plus, McDonald’s huge excess cash shows that it will keep on rewarding its shareholders in the form of growing dividends. Apart from this, McDonald’s low price presents a great opportunity for long term gains. In short, buy McDonald’s for an upside of 9%.
Waqar Saif has no position in any stocks mentioned. The Motley Fool recommends Burger King Worldwide (NYSE:BKW) and McDonald’s. The Motley Fool owns shares of McDonald’s.
The article Have Faith in Ronald McDonald originally appeared on Fool.com and is written by Waqar Saif.
Waqar is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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