McDonald's Fails To Impress With Its Last Quarter

| About: McDonald's Corporation (MCD)

On Monday the share price of McDonald's (NYSE:MCD) fell by nearly 3% after the company posted disappointing earnings results. Apparently, the investors were more worried about the company's guidance than they were about its past performance.

In the second quarter, McDonald's earned $1.4 billion up from $1.35 billion in the same quarter a year ago. Per share basis, the company's net income was $1.38 per share versus $1.32 per share in the second quarter of 2012. This falls below the average analyst estimate, which was looking for $1.40 per share in net earnings on revenue of $7.09 billion, which is slightly above the actual revenue of $7.08 billion. While the global same-store sales growth beat analyst estimates (1.0% vs. 0.8%) the American same-store sales growth failed to meet the estimates (1.0% vs. 1.5%).

McDonald's blamed macro-economic conditions for its weak results and guidance. The company also announced that it would open fewer new stores around the world, particularly in China. Earlier, it was predicted that McDonald's was going to open up to 1,600 new stores globally, which is now revised down to 1,500 to 1,550 range because McDonald's expects the challenging conditions to continue until the rest of the year.

It looks like people around the world have less extra income to spend on going out to eat and many people prefer to stay home for meals. I would have expected McDonald's to benefit from this trend since the company tends to offer cheaper meals; however, in some parts of the world the company's offerings might not be as cheap as they are in the western world. In places like Europe, eating out has high tax consequences with tax rates around 25%, which makes it less likely for people to eat out, especially in the face of the recession the continent is going through right now.

In Europe, the company's same-store sales were nearly flat as it performed well in the U.K. and Russia while performing badly in Germany and France. It's important to note that the franchised restaurants posted twice as much revenue growth as company-owned restaurants (2% vs. 4%) even though the great majority of the company's revenues came from company operated restaurants ($4.76 billion vs. $2.32 billion). Keep in mind that the company counts all of the revenues in company-operated restaurants; whereas, only a part of the revenues from the franchised restaurants count towards the corporate numbers.

Both operating margin and net-profit margin were flat compared to the same quarter last year. McDonald's operating margin was 31.16% and net profit margin was 19.48% in the second quarter of 2012 as opposed to 31.02% and 19.71% in the second quarter of this year. As the company already has one of the strongest margins in the fast-food industry, it may be difficult to improve these numbers any further.

We see some interesting trends if we look at the first half of the year as a whole as opposed to the second quarter alone. In the first half of 2013, the revenues were up by 2% compared to the first half of 2012. If we look at some items that make up the margins, company operated restaurant expenses were up by 2% (at the same rate as revenue growth), franchised restaurant expenses were up by 6% (much higher than the revenue growth rate) and selling, general and administrative expenses were down by 1%; while, "other" operating expenses were down by 2%. The total operating expenses rose by 2%, which is the same rate as revenue growth, keeping the operating margin flat in the first half of 2013 compared to the first half of 2012.

Part of the unimpressive results could be blamed on currency rate fluctuations since the company operates in many, many countries in the world. The currency fluctuations accounted for a 2-cents per share decrease in the company's earnings in the last quarter. Without the currency rate fluctuations the company would have earned $1.34 per share instead of $1.32 per share. The company attempts to control the effects of currency rates by obtaining its supplies from local markets where it operates.

As we move forward, McDonald's doesn't expect things to improve anytime soon. Due to strong competition, the company is unable to raise its prices and it is very difficult for it to cut costs since it works at a highly-efficient manner and there isn't much to cut. There are also costs outside of the company's control such as commodity expenses and some employee expenses that are regulated by local governments such as minimum wage and certain benefits that need to be offered in certain countries. Also, it will be interesting to see how McDonald's gets affected once the Affordable Care Act is fully in effect in the U.S.

Currently, McDonald's is trading pretty close to my target price of $100; therefore, I wouldn't buy shares of the company. Of course, those that are close to their retirement and looking for a dividend payer with low risk can still find a lot of value in this company.

Recently, Chipotle (NYSE:CMG) also announced its earnings and the company's strong growth continues. Several months ago, I was able to call the bottom in this company and made some decent money investing in it. Since then, the company's share price has recovered and many investors saw their portfolios grow rapidly after adding the company in it. Chipotle's comparable-store growth alone seems to be bigger than McDonald's total growth, which makes it a better bet for growth investors. McDonald's isn't likely to see a sharp fall after this, but it is not likely to see a sharp increase either. I expect the company to trade at a thin range for a while.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.