When McDonald's (MCD) reported its February sales earlier this month, investors celebrated the results. Granted, MCD shares had dipped ahead of the release on fear of a recurrence of the global comparable sales deterioration like that seen in January. Still, did investors really just celebrate McDonald's zero U.S. growth and operational volatility overseas? There seems to be a disconnect between the stock's valuation relative to growth expectations and the company's bumpy recent results and uncertain outlook. I think it's about time for the market to reevaluate MCD and consider the strong argument I see against the stock. Monday's 1.0% decline seems to evidence that it may have begun to do so.
It was March 8, 2013 when McDonald's reported its same-store sales data for February. There was an adjustment made for an extra day in the 2012 leap year period. Here are the numbers again after that adjustment:
February Comparable Sales
· APMEA - Asia/Pacific, the Middle East and Africa
The investment community celebrated these results, despite their mediocrity, especially in the important American market. It's because the numbers represented improvement over the prior month's trouble. The stock had sold off into the report, on concerns about the prior month's soft data. So a relief rally of sorts ensued when this report reached the wire. You can see the pre-release selloff illustrated in the chart above. Still, the celebration seems excessive nonetheless.
Appreciation March 7 - 22, 2013
SPDR S&P 500 (SPY)
SPDR S&P Retail (XRT)
Burger King (BKW)
Yum! Brands (YUM)
From March 7, the day before the release, to the close of March 22, MCD shares outperformed the broader market and edged out the retail sector. Still, there is something telling in the comparison to fast food rivals Yum! Brands , Burger King and Wendy's, which all outgained McDonald's over the span. This perhaps illustrates skepticism about McDonald's, and could imply weak support of the shares.
Supporters of MCD shares will argue that the prior year comparable sales figure for February was a tough match, since it marked a gain of 11.1% over its own comparable in 2011. However, the important fact is that the 2012 period contained an extra day, for which the company accounted and adjusted for in the February 2013 sales report. We would be amiss to not also account for it in the comparison between the 2012 and 2011 period. We cannot notice it when it works in our favor and ignore it when it does not.
Now, McDonald's spoke generally of the positive impact of the extra day in last year's February sales release, saying that it was approximately three percentage points for each reported segment. That would bring the same-store sales rate down to a still high 8.1% in the U.S. in February 2012. I suspect the generalization is understating the impact to U.S. sales (I'm implying it might be more than 3 points), and that other issues including days of the week included in the period versus its comparable came into play. In other words, and based on my experience as an analyst, I'm not buying such a strong domestic sales pace for such a mature company, despite the product catalysts attributed for it. Those who may have the complete data set for U.S. sales last February are welcome to add it in the comment section below.
McDonald's shares trade at a P/E ratio of 17X the analysts' consensus EPS estimate of $5.78 for 2013. That compares to the 7.8% EPS growth estimated by analysts for this year and the 9.3% EPS growth estimated for the next five years. The forward growth outlook is expected to benefit from expansion in Asia and a recovering European market. However, Europe is still deteriorating and Asian growth has proven significantly less predictable and manageable than I expect investors had counted on. The stock trades at a PEG ratio of 2.2X or 1.8X, depending on which growth estimate we use. Each of those is too high in my view and given current circumstances. Also, I do not believe the market has fully understood or incorporated the Better Burger Threat to McDonald's domestic business yet, and I encourage readers to see the report I published on the subject in January.
In conclusion, while it's true that McDonald's same-store sales results for February were better than recent history, zero growth in its U.S. market is not enough. As we approach the March sales report, due in about two and half weeks, I expect the market will again grow concerned about McDonald's sales. I reiterate my opinion that McDonald's shares should be sold because of important threats to its business both at home and abroad, and given a valuation that overstates growth and seems to overlook my outlined concerns.