Fast-food goliath McDonald's (MCD) posted first quarter results revealing a great deal of weakness in its core business. Revenue rose 1% year-over-year to $6.6 billion, a tad higher than consensus expectations. Earnings per share were roughly in-line with consensus estimates, rising only 2% year-over-year to $1.26 per share.
More worrisome, McDonald's same-store sales declined 1% year-over-year driven by a 1.2% decrease in same-store sales in the United States. Operating income in the region declined 3%. The firm released a few new items like Fish McBites and premium wraps, but new products were unable to push the needle it terms of sales. McDonald's emphasized its continued focus on value and the dollar menu, which, in our view, might constrain revenue growth. With the majority of the firm's revenue and earnings driven by sales at franchisees, stimulating sales growth continues to be the primary focus. CFO Peter Bensen reinforced that statement saying:
"For now, it is the market share battle and we are determined to continue making the necessary adjustments to maintain and grow our share, because that is how we will win over the long-term."
Unfortunately for McDonald's, we feel the company is not creating menu innovations at the pace it was just a few years ago. As we've said before, it will be hard for the company to pull another gem out of its hat to the same magnitude as McCafe. Further, focusing on market share and value makes it difficult for franchisees to achieve solid returns, making it plausible that these entrepreneurs look to put their money to work elsewhere or simply invest less in the company. However, if we see some easing in commodity costs, we think franchisee dissatisfaction could dissipate.
Moving to Europe, same-store sales slipped 1.1%, though constant currency operating income grew 1%. Management identified France and Germany as the drivers of weakness, and CEO Don Thompson stated that the company is focusing on expanding value offerings in countries to help drive sales. We think it will be difficult for the company to win sales from frugal German customers if the greater economy fails to improve.
On the other hand, the UK and Russia were strong in the first quarter. Growth in the UK seemed to be tied to special, limited items and menu expansion rather than a focus on value. Ideally, this is the growth we'd like to see worldwide rather than just value menu expansion. Russia experienced a nice boost from new product offerings, but the country also performed well thanks to improving breakfast offerings. Over the last few years, breakfast was among the strongest driver of sales growth in the US, and we anticipate the strategy to work well in more markets.
Asia-Pacific, Middle East, and Africa (APMEA) results were particularly soft, as same-store sales declined 3.3% and operating income fell 2%. Although the company believes the aforementioned breakfast offering can be a huge sales driver (it represents 11% of sales in APMEA vs. 25% in the US), the segment faces several broader macro issues in a few of its largest markets. Japanese consumption has been constrained for the past few years, and the company doesn't seem encouraged about the near-term prospects. China, which could be one of the firm's largest growth drivers, experienced a 4.6% decline in same-store sales as the entire industry deals with the fallout from supply-chain issues. We like how the firm has continued to build new stores, and we believe consumer confidence in the industry will improve as chicken scare gets pushed further in the rearview.
Overall, we weren't thrilled with McDonald's first quarter results. Sales growth was weak, and margin expansion does not look to be in the cards for 2013. Nevertheless, the firm remains a cash cow, and we like management's willingness to aggressively allocate capital to dividends, repurchases, and internal investments. McDonald's share price has been resilient in spite of declining fundamentals, but we do not think that current prices make for an attractive entry point.