Does A Tough Patch Really Matter To McDonald's Shareholders?

Excellent earnings consistency and a long history of dividend payments will buy a lot of patience and support from investors. Consequently, I find it hard to imagine that even this disappointing patch of weak same-store sales will really dent McDonald's (NYSE:MCD) all that much. Though I'm not very fond of the multiples being paid for consumer stocks these days and won't be looking to add McDonald's to my own portfolio, I don't expect a mass exodus from these shares unless the market as a whole takes a tumble.

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Q1 Results Thin On Growth
Sell-side analysts weren't expecting great things from from McDonald's this quarter, but the company's performance was soft all the same. Revenue rose just 1%, as revenue from company-owned stores was flat and revenue from franchised stores increased 2%. Relative to what we've heard from Yum! Brands (NYSE:YUM) recently, it wasn't so surprising that McDonald's saw weakness across the globe – revenue from the U.S. was down 1%, while Europe and the APMEA region were up 2%.

With such a large footprint of stores, comp-store growth pretty much guides McDonald's performance. To that end, a 1% decline in comps was disappointing, as both the U.S. and Europe saw a small decline, and results for the month of March were weak.

McDonald's is also struggling to generate margin leverage in this environment. Reported operating income was flat with the year-ago level, and the company reported more than one point of company-operated store operating margin erosion largely due to higher payroll and occupancy costs.

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Ongoing Innovation Should Keep Traffic Flowing
McDonald's is unusual in the quick service restaurant (QSR) space for its pace of menu innovation. McDonald's is always working on something new and the company is quick to yank products that aren't earning their keep. To that end, the company is looking to launch new breakfast products and support an expanded line of wrap products – a group of food offerings that some McDonald's executives have reportedly referred to as “Subway-busters”.

Of course, success in the QSR space isn't just about innovative and exclusive products. If it were, Sonic (Nasdaq:SONC) should do better than it does. While it probably won't be long before Burger King (NYSE:BKW) tries to match McDonald's with follow-on products, McDonald's continues to look for ways to keep costs down and margins up, and the ability to offer such a strong value menu without compromising margins has proven to be a powerful factor in the company's significant market share growth in recent years.

Is Service A Real Problem?
McDonald's investors have likely noticed more media attention recently on declining customer satisfaction with service levels at McDonald's. While I'd be sorely tempted to remind the complainers that you get what you pay for and that expectations should be different between QSRs like McDonald's and hybrid concepts like Panera (Nasdaq:PNRA) and Chipotle (NYSE:CMG), management is taking the issue seriously.

While skeptics (like me) will argue that there's only so much service you can expect for the wages McDonald's pays, the reality is that the unemployment situation in the U.S. probably means that McDonald's could find motivated new employees if they need to go that route. That said, it's worth following this story in the coming quarters, as it's not often that low prices and high services travel together.

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The Bottom Line
As I said in the intro, I don't see all that much value in McDonald's today and I do worry that investors may be too complacent if they expect McDonald's to match the volume and margin improvements that the company has managed over the last five years into the next five years. While there is long-term potential for market penetration and better margins in the international operations, I want to emphasize the “long-term” part of that statement – restaurants like McDonald's, YUM's KFC, and Subway are relative luxuries in many parts of the world, and it will take years for that to change.

Given McDonald's below-market risk (in terms of earnings volatility, at least), there's no particular reason that the stock should be priced for market-matching performance. That said, I do worry that investors have piled into consumer stocks a little too heavily, and I think McDonald's at today's prices isn't all that compelling unless you're content with mid-single digit returns.

At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.

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Categories: Matter, McDonalds, Patch, Really, Shareholders, Tough