Fast-food chain McDonald's (MCD) reported mediocre third quarter results. Revenue growth was weak, coming in flat year-over-year, though up 4% on a currency-neutral basis, in-line with expectations. Earnings fell 1% year-over-year to $1.43 per share, a few cents lower than consensus estimates. To learn how to calculate McDonald's fair value estimate via a discounted cash-flow process, please click here.
Weakness was broad-based, with aggregate same-store sales growing only 1.9%. The weakest geographic region was surprisingly the US, where same-store sales grew only 1.2% year-over-year. The firm has tried to move away from its value offerings to grab margin dollars as input costs soar, but the change hasn't been effective. Still, management expects the McRib and the introduction of the Cheddar Bacon Onion to drive incremental growth in the US during the fourth quarter and first quarter of 2013.
Europe was weak, with same-store sales up 1.8%, driven by strength in the U.K, Russia, and France and weakness in Germany. The company gained market share, even though traffic during the quarter declined. Due to broader economic weakness, McDonald's has focused its efforts in Europe on value, which is great for market share but not necessarily for profitability, as operating margins fell 50 basis points to 20.4%.
Asia-Pacific, Middle East, and Africa same-store sales grew 1.4%, driving earnings 3% higher. Unlike the developed world, emerging markets are facing constant wage inflation, which contributed to operating margins falling 150 basis points to 16.9%. While sales in Japan were weak, Australia and China both performed well, and management noted that the company has grown market share in China. Without question, China represents a compelling and potentially highly-profitable opportunity for McDonald's. Although tier 3 cities are currently underperforming tier 1 and 2, management expects growth in drive-thru restaurants (and auto adoption) to accelerate growth.
Overall, we didn't think McDonald's third quarter results were good. The firm's aggressive pricing during the past few years has been one of the key drivers of success, but its recent attempt at raising prices and limiting value offerings hasn't resonated with consumers. If prices are in-line with industry averages, consumers in the US have shown a willingness to explore other fast-food options, whether it be Wendy's (WEN), Burger King (BKW), or Taco Bell (YUM).
We're not interested in shares at current levels, though we think the firm continues to have a fantastic dividend and strong long-term potential. McDonald's scores only a 4 on the Valuentum Buying Index (our stock-selection methodology).