Soft Sales Growth At McDonald's Is No Surprise

| About: McDonald's Corporation (MCD)
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Fast food heavyweight McDonald's (NYSE:MCD) reported an uneventful second quarter. Revenue increased 2% year-over-year to $7.1 billion, in-line with consensus estimates. Earnings per share fell a few cents short of consensus estimates, growing 5% year-over-year to $1.38 per share.

CEO Don Thompson tends to cite the macroeconomic environment as the main driver of persistent weakness at McDonald's. This argument certainly holds weight in Europe, in our view, but we do not believe the soft 1% same-store sales growth rate in the US was macro-related. Rather, we think the company's premium product offerings aren't packing the same punch as new products did in previous years. McDonald's performed relatively well during the Great Recession thanks to its Dollar Menu and focus on value, but we think that same dynamic is coming back to hurt the company now. Customers realized they were satisfied with getting a cheaper McDouble and didn't need to spend additional funds to get a Big Mac or another higher-priced item.

According to Thompson, the Dollar Menu remains an integral part of the sales mix, saying on the conference call:

"The Dollar Menu itself still represents about 13% to 14% of sales, which is still in that same range it's been in. What has benefited us has been the fact that it is a consistent execution and it still has tremendous alignment across the franchises and the McOpCo restaurants that we have. So it is the value platform of choice. Now we've done a couple of things to try to add some new news to that which also help us to be a little bit more margin accretive, things like the Grilled Onion Cheddar Sandwich, Hot 'n Spicy McChicken limited time offer selections that we placed into the Dollar Menu. Even having done those, we still remain at 13% to 14% of sales based upon the Dollar Menu."

Consumers aren't trading up at McDonald's, and we have no indication at this point in the economic cycle that it will change anytime soon, especially as consumers opt for higher-end choices like Chipotle (NYSE:CMG) and Panera (NASDAQ:PNRA).

European same-store sales were down just 0.1% year-over-year during the quarter. Though obviously not great, we think the number is acceptable given the macro issues at work in Western Europe. Same-store sales in the firm's Asia-Pacific, Middle East, and Africa (APMEA) region declined 0.3% year-over-year as same-store sales in China tumbled 6.1%. Such a decline is not too surprising in the wake of the Yum! (NYSE:YUM) poultry scandal. However, the steep decline actually implies a market share gain-precisely what McDonald's needs in order to provide a shot in the arm to sales growth.

Valuentum's Take

With July same-store sales flat and management expressing concern that 2013 will be a "challenging year," there is not a whole lot of positivity surrounding McDonald's at this juncture. The firm may be a victim of its own success-crushing the competition with its Dollar Menu, but creating unrealistically low price expectations that has cannibalized sales of higher ticket items. McDonald's could get a boost from expanding breakfast hours, but we think the company needs to create some new great products (think McCafe).

Even though growth isn't looking great for 2013, the company could easily return to expansion as the macroeconomic environment improves abroad. We think shares look fairly valued, and we're not looking to build a position in our Dividend Growth Newsletter portfolio.

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.