Is McDonald's as Lucrative as It Used to Be?
As McDonald's continued to face tough competition from Yum! Brands , Burger King , and Wendy's in the U.S. market, its November same-store sales didn't grow as much as expected. After the company released its sales report, its share price fell by more than 1%. From an investor's point of view, does this mean that McDonald's isn't as lucrative as it used to be? Let's find out.
November same-store sales
During the last few months, McDonald's same-store sales haven't been showing much promise. In November, its comparable-sales in the U.S. dipped by 0.8%, but according to Consensus Metrix analysts expected a 0.3% gain. In Europe, McDonald's same-store sales grew by 1.9% while Asia/Pacific, Middle East, and Africa, or APMEA, witnessed a 2.3% decline in comparable sales.
What went wrong?
Tough competition from rivals and low consumer spending have been the major reasons behind McDonald's declining growth. McDonald's CEO Don Thompson has not only changed the company's top management, but he has also altered its menus. Still, the company has not been able to beat its competitors, which offer menus that include lower prices. Of all the menus that McDonald's currently offers, only the breakfast menu has been consistently outperforming its rivals. With all other menus, McDonald's still lost out.
As McDonald's tried to cope with its slumping sales growth, it introduced a wide range of new items without doing substantial research. In an industry where "food serving time" has great significance, new items such as smoothies, lattes, and salads have complicated McDonald's operations and slowed its service to an extent. Long lines, mostly at lunchtime, have forced customers to leave its restaurants. According to research conducted by QSR Magazine, McDonald's average drive-thru service speed was clocked at 189.49 seconds, the slowest in the study's fifteen year history. This testifies to the fact that McDonald's has been losing many customers due to delays in delivering food.
What is McDonald's up to?
In order to speed up the assembly process, the company plans to invest in new preparation tables at U.S. locations that can accommodate more ingredients. It is also distributing a new customer feedback system to all stores in the U.S. The system will ensure that customer complaints reach its restaurants directly so that issues can be resolved quickly. McDonald's is also improving its kitchen operations, especially for the lunch period, so that customers can be served on time.
I have always been a fan of McDonald's dividend, which has consistently grown over the last ten years. The company still has one of the highest dividend yields in the industry at 3.40%. McDonald's free cash flow stands at $4.2 billion, while its levered free cash flow is $3.74 billion. In other words, it has free cash flow per share of $4.22 and levered free cash flow of $3.76 per share. This indicates that although McDonald's isn't growing that much, it still has a lot of excess cash on its books. Therefore, it can keep on growing its dividend in the future as well. Plus, this excess cash means that McDonald's can easily execute its share repurchase programs in the near future, giving its stock price a much needed kick.
McDonald's trades at a low forward P/E of 16 which indicates investors' low confidence in the company. Many investors hold the view that the company won't be able to multiply its earnings that much in the next year. McDonald's low price-to-sales ratio of 3.4 tells the same story. This is because McDonald's revenue hasn't grown a great deal in the recent past. A quarterly revenue growth rate of just 2.40%, year-over-year, proves this fact. In short, McDonald's looks great for dividends but not for capital appreciation.
The fast-food giant Yum! Brands has struggled throughout the year amid poultry issues and an avian flu outbreak in its biggest market -- China. However, as these issues have subsided Yum!'s sales are growing once again. November sales show that the company is gradually getting back on track. Yum!'s November same-store sales in China grew by 1%, including flat sales at KFC and a 7% rise at Pizza Hut. The company is gaining strength in China, as its comparable-store sales had previously declined by 5% in October. Renewed customer confidence plus the new half-price chicken promotion at KFC restaurants have contributed to better sales.
On the other hand, Burger King's third-quarter results show that its same-store sales in the U.S. and Canada dipped by 0.3%. The reasons behind this slow growth were intense pricing competition between rivals and slow consumer spending. As with McDonald's, the U.S. market is significant for the company as 40% of its business is in this region. In order to focus more on speeding up its service, Burger King plans to keep itself away from seasonal and limited-time menus. However, as restaurants face tough competition it won't be easy for Burger King to grab significant market share.
As the restaurant industry continues to grow at a meager rate, McDonald's won't be able to generate high revenue growth in the near future. Moreover, more competition in the market means low pricing, which will continue to affect McDonalds' operating margin. Initiatives such as new preparation tables will increase revenue, but not to a great extent. McDonald's growth relies heavily on consumer spending in the U.S, which again is growing but at a very slow rate. Therefore, don't expect high capital returns from McDonald's, but it's a great buy for dividends. In a nutshell, I remain neutral on McDonald's.
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The article Is McDonald's as Lucrative as It Used to Be? originally appeared on Fool.com.Waqar Saif has no position in any stocks mentioned. The Motley Fool recommends Burger King Worldwide and McDonald's. The Motley Fool owns shares of McDonald's. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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