Shares of McDonald's (MCD – Free McDonald’s Stock Report) slipped after the restaurant operator released second-quarter financials that did not live up to investors' expectations. Revenues of $7.182 billion rose less than 1.5% from a year earlier and fell short of our $7.300 billion call. The year-over-year gain stemmed almost entirely from restaurant expansion and price increases, as global comparable-store sales were flat in the quarter and guest traffic was negative in all of the company's geographic segments. Operations appeared to grow more difficult as the interim progressed, and comps rose 1.2% in April and 0.9% in May before pulling back in June.
Once again, the United States posed the biggest challenges for McDonald's. To wit, same-restaurant sales on our shores fell 1.5%. Although weather wasn't a problem like it was in the first quarter, competition remained fierce as other players in the quick-service restaurant segment tried to wrest market share from McDonald's. Results in Europe were slightly better, although comps were still in negative territory, falling 1.0%. Solid results in the United Kingdom and France were offset by ongoing weakness in Germany. Management's barbell strategy of emphasizing both premium menu items and the core value menu helped support results, as did the roll out of blended ice beverages in a number of markets. The region comprised of Asia/Pacific, the Middle East, and Africa did better, posting a same-store sales gain of 1.1% in the June period. China delivered a strong performance, as did several other markets, somewhat offset by softness in Japan. Initiatives to enhance convenience and value paid off, as did targeted, locally-relevant promotions.
In terms of profitability, SG&A expenses rose as a percentage of sales from a year earlier. The same was the case for total operating costs, all of which weighed on the operating margin. A higher tax rate did not help the bottom line, either, although per-share comparisons were aided by a decrease in the number of shares outstanding. Finally, foreign currency translation had a positive impact on share net to the tune of $0.01, enabling earnings to come in at $1.40 a share, just slightly higher than the comparable 2013 figure of $1.38, but below our $1.44 forecast.
Overall, operating conditions did not seem to change too much in the second quarter relative to the first except for the weather. Competition for consumers' dollars was still fierce, especially in the breakfast segment. McDonald's has long been a leader in this meal, but competitors are working hard to get a bigger slice of this profitable pie. Management recognizes that it needs to improve customer service and throughput, as its increasingly large and complex menu leaves more room for customization, resulting in longer wait times. Still, such efforts (like introducing new, more efficient preparation stations) take time to implement, as do initiatives to improve marketing, build a more formidable digital presence, and become a more trusted brand. Combined with ongoing cost pressures, the operating environment is not expected to change much through the rest of 2014. Indeed, global comps in the second half of the year will likely be in line with the first half, with the July figure expected to be negative. All told, we have trimmed our earnings estimates by a dime and now look for the full-year 2014 tally to be $5.65 a share.
Although near-term results will probably remain under pressure, we think that MCD stock has appeal for conservative investors with a penchant for current income. The issue's yield is well above the Value Line median, and management is committed to returning money to investors through increased dividends and share repurchases. Indeed, the company intends to return $18 billion to $20 billion to investors between 2014 and 2016, a 10%-20% increase over the amount returned between 2011 and 2013. These initiatives are supported by the company's ample free cash flow and ability to borrow at favorable rates (Financial Strength is A++). Finally, MCD stock carries Value Line's Highest ranks for Safety (1) and Price Stability (100), as well as a below-market Beta of 0.60.
About The Company:McDonald's is a quick service restaurant with over 35,000 locations in more than 100 countries (as of June 30, 2014). The majority of the restaurants (over 80%) are operated by franchisees or affiliates. The company is best known for its hamburgers and French fries, but it now has a diverse menu that includes breakfast items and an array of coffee-based drinks.