This past week McDonald's (NYSE:MCD) reported its 2nd-quarter earnings for 2012. MCD reported that its overall earnings decreased by 4.5%. This decrease was directly attributed to the negative impacts of currency volatility. MCD overall generated a net income for the quarter of $1.347 billion or $1.32/share. Unfortunately, these numbers for the quarter not only missed the street's estimates of $1.37/share, but also missed last year's net income numbers of $1.41 billion or $1.35/share.
Although, MCD's numbers did not produce the stellar outcomes the street had hoped for, I think it is important to note that sales actually did increase by 0.2% or 5% when currency adjustments are not taken into account. Overall, the market did not view this quarterly report as being extremely positive with the stock now trading between $88 and $89 per share. This is down from the company's high that was made earlier this year of $102.22/share.
MCD competes with several other well-known fast food chains, including Wendy's (NASDAQ:WEN), YUM Brands (NYSE:YUM), and Burger King Worldwide (NYSE:BKW). Currency fluctuations are inevitably going to happen to a company the size of MCD and should be expected. Unfortunately, due to the current global economic climate I am starting to wonder whether MCD's quarterly expectations are just too high and not taking this into account. If the company is unable to actively manage its currency exposure, what other areas is it having difficulty in managing?
I pose this question because a main input cost in MCD's business model is beef, pork and poultry. The majority of the livestock in this country are fed on a daily basis some type of corn meal or corn stock. As this year's drought continues to rage through majority of the Midwestern United States corn and soybean prices have continued to soar to new highs. Corn is now trading for over $8/bushel, while soybeans trade for around $16/bushel. The price increases in corn and soybeans are also driving up the price of other related agricultural commodities. Primarily the prices of beef, pork, and poultry, which ultimately as these prices continue to climb it is only a matter of time before they take a bite out of MCD's profit margins. If profit margins continue to experience added pressure it is going to be increasingly more difficult for MCD to meet earnings estimates in future quarters.
These types of increases in input prices are being felt across the globe at a handful of companies this earnings season. Coca-Cola (NYSE:KO) noted in its most recent earnings report that its biggest concern for the remainder of the year was the possible negative impacts of higher commodity prices on its overall profit margins. Most companies pass some of the increased input prices onto the customer, but in the case of MCD one must ask, how much value can MCD continue to take out of its value meal before the company starts to lose business to competitors? This is what concerns me when examining the results of MCD recent quarter. The decreased numbers and the fact that MCD lowered guidance for the remainder of the year only creates greater uncertainty leading into next year.
I think it is also important to mention the growing fear that the United States and Europe might slip back into recession toward the end of this year, which would put additional pressure on MCD's potential sales and margins. Additionally as the United States quickly approaches its fiscal cliff deadline additional tax implications could also play a large role in decreased margins for MCD. During Chipotle Mexican Grill's (NYSE:CMG) most recent quarterly report the company mentioned that it was feeling the effects of the economic slowdown and decreases in consumer spending and confidence. The company also mentioned that current weather conditions in the country would put further pressures on overall food costs which may impact margins in the second half of 2012 and into 2013.
After hearing that kind of guidance from a company like CMG, I start to wonder what the real fair market value of MCD might be. To try and determine this I thought I would dig a little deeper into the company's fundamentals and try to assess what the real fair market value of MCD might be.
- MCD currently has a book value of $14.42/share. At the company's current price this means that MCD is trading for roughly 6X book value. That's not extremely high, but considering the current economic conditions I would prefer that metric to be lower. A book value closer to 3X - 4X would be preferred.
- The company generated $1.32/share this quarter and after adding back in the prior three quarters' numbers ($1.23, $1.33, & $1.45) the current EPS is $5.33/share. With a $5.33 EPS and the stock trading for around $88.50/share return on equity would be roughly 6.02%. This is not terrible, but there are better investments out at comparable prices that would give you a far better return on equity.
- An EPS of $5.33 gives MCD a P/E ratio of about 16.51, which to me does not scream value. I ideally like to buy companies that are trading somewhere between 10 -13 times earnings. In that case MCD would have an ideal stock price somewhere in the range of $53 - $70 per share.
- MCD currently has $2.29 billion in cash on hand with $12 billion in long-term debt. The cash on hand is respectable, but considering the potential economic headwinds that the company might be facing in the coming quarters I would like to see greater cash reserves on hand.
- Looking ahead to next quarter the average estimate for revenue is $7.27 billion with EPS estimates at $1.51/share. Next year's estimates are currently $27.82 billion with EPS at $5.46. This is slightly above the company's current EPS. When considering all of the previously mentioned environmental factors that could (and will) impact the pricing power of MCD I find it hard to believe that MCD will be able to meet or even exceed those expectations.
After looking through these numbers I feel that MCD fundamentally is doing okay, but not great. After seeing this recent quarter's numbers and guidance I think that the market will begin to reflect this new information in the price of MCD and the stock will trade down because of it. My overall short-term outlook on MCD may seem a bit grim, but I feel that it is important to really determine what factors will be impacting MCD pricing power and performance before I commit any capital to the stock. Unfortunately, it seems that it might be a while before the market starts seeing MCD trading for $102/share again.