McDonald's (NYSE:MCD) reported its April same-store sales results a couple of weeks ago, noting same-store sales deterioration in 2 of 3 major market segments and just 0.7% growth in the U.S. The company's international expansion was supposed to add growth to the McDonald's story, but it was sorely missing in April. So where's the beef behind the stock's recent climb?
Last Friday, we learned that Yum Brands' (NYSE:YUM) China Division experienced a 29% same-store sales decline, so McDonald's was not alone in the weakness it experienced in what was supposed to be an important growth market. YUM's KFC brand in China saw impact from national avoidance of chicken due to the spread of a new strain of avian influenza, H7N9.
McDonald's April same-store sales were down 2.9% in the company's Asia/Pacific, Middle East and Africa (APMEA) segment. The company said sales were soft due to avian influenza fears mostly in China, but also on sales softness in Japan and Australia. This illustrates the worst case scenario should the new bird flu strain spread to other regions of Asia and beyond. Readers of this column had an early heads-up regarding the impact of bird flu on McDonald's.
There is concern about this latest strain because it does not always make birds sick, and so it can pass undetected for some time among flocks. The issue is understood by disease specialists, but I believe it might be harder to get Asian farmers to test healthy flocks of birds and to justify to them the culling of such flocks. Thus, this version of the bird flu might more easily get out of hand in my opinion.
But China is not the only area of concern for McDonald's. Another of its international expansion target areas, Europe, also remains strained. European economic issues are well understood, and the region is still deteriorating based on the latest downgrades to economic forecasts at the ECB and elsewhere. But McDonald's offerings are supposed to be well-suited to value oriented consumers. Why then did the European area same-store sales fall 2.4% in April? In my own experience in Europe, I came to realize that the McDonald's brand allows it to charge relatively more than it does in the U.S. So Greeks can go pick up a souvlaki on a stick or a gyro for a lot less than a Big Mac, or its European facsimile. Also, as any self-respecting Greek can attest, Greek mothers never stop cooking at home, so there's always a lower cost option. In times like these, mom's home cooking is greatly appreciated.
In the U.S.
Just this past weekend, I enjoyed a cheeseburger at a joint called BurgerFi on the Upper East Side of Manhattan. I have a shorter walk to at least four specialty burger joints now than I do to get to my nearest McDonald's or Burger King (BKC). At BurgerFi, I ordered a beer and watched playoff hockey and basketball while sitting outdoors on a nice night. I cannot do any of those things at McDonald's, nor would I, due to the brand impression established on my psyche.
As I documented in my article, The Better Burger Threat to McDonald's, the company is facing an intensifying competitive environment in what it does best, burgers. I think it's evident in the company's domestic same-store sales results. This month, it managed 0.7% growth on some innovative efforts, but there's only so much juice you can squeeze from an orange. And McDonald's serves oranges, so to speak, not lemons, so don't get me wrong. I happen to love McDonald's breakfast sandwiches, and would not go anywhere else for a competing version. But it's also facing a competitive threat there, where Dunkin' Brands (NASDAQ:DNKN) just introduced a Turkey Sausage Breakfast Sandwich as a healthier option for the morning meal. Yum Brands' Taco Bell business just introduced Waffle Tacos to compete for breakfast share as well.
Yet, McDonald's shares are up 15.5% year-to-date through May 16, including the dividend. Where's the beef behind this rise, given the company's same-store sales issues that have shown up over various months? In my view, McDonald's is just another one of the widely held dividend paying stocks that have benefited from the massive influx of capital into equity funds in 2013. That influx led institutional managers to simply beef up positions they already held in America's staple stocks, including in widely held MCD. But given the argument I make against the stock's story here, can it hold its newfound valuation?
Growth is slowing for McDonald's, according to analysts following the stock. Yahoo Finance data indicates that analysts are forecasting just 8.7% average annual growth for the next five years despite the company's expansion into Asia. That compares with its last five years' growth of 10.5%. The stock's P/E measures at 17.7X the analysts' consensus estimate for 2013, giving it a P/E-to-growth ratio of 2.0. All right, it pays a dividend of 3.1%, but if I incorporate that into the growth forecast, I still get a PEG ratio of 1.5X. That's for a company with EPS estimates that are being ratcheted lower. Over the last 90 days, analysts on average have cut their 2013 EPS estimate by $0.08 and the 2014 number by 10 cents. I have trouble defending a PEG ratio like this under these circumstances, and am asking those on the long side, where's the beef behind this valuation?