McDonald's sees unprecedented slowdown

Normally, 1 or 2 of the company's top 10 markets might struggle. Now, for the first time, it's seeing trouble across the board.

By Jim J. Jubak Jul 24, 2012 4:28PM
That was one depressing conference call. Oh, not because the results McDonald's (MCD) announced Monday were so bad or because the company slashed guidance. McDonald's did miss Wall Street's 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 that 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. 

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Normally, new CEO Don Thompson said, the company might see one or two of its top 10 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-image -- 2,400 restaurants in 2012 and open 1,300 new restaurants in emerging markets.McDonald’s restaurant © AFP/Getty Images

In the new wrinkles category, McDonald's launched a "Loose Change Menu" with seven menu favorites -- a small order of fries or a 10-piece chicken McBites, for example -- 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%.

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 10-year U.S. 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 so that they're willing to invest in refreshing their stores and to follow the company’s lead on unified positioning such as 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, 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. Competitor Yum Brands (YUM) sells at a trailing 12-month price to earnings ratio of 20.9.

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.

At the time of this writing, Jim Jubak didn't own shares of any companies mentioned in this post in personal portfolios. The mutual fund he manages, Jubak Global Equity Fund (JUBAX), may or may not own positions in any stock mentioned. The fund did own shares of McDonald's as of the end of March. For a full list of the stocks in the fund as of the end of the most recent quarter, see the fund's portfolio here. 


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