McDonald's (MCD) Gets Squeezed in Asia, But Remains Strong in the U.S. and Europe

Shares of fast food giant McDonald's (MCD: Charts, News) have been on a losing streak lately, shedding 12% of their value year-to-date. The stock was the best performing Dow component of 2011, rising 30% and outperforming a tepid 6% gain in the Dow. The recent pullback was caused by fears of a slowdown in Asia, Europe and other emerging markets - the main avenues of growth for the largest fast food company in the world.

On June 8, the company reported a same-stores sales decline of 1.7% in its Asia Pacific, Middle East and Africa regions, the steepest decline in eight years. Analysts had forecast a 3.2% gain for the segment. Global same-store sales increased by 3.3%, also missing the analysts' expectations of a 5.2% gain.

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A Chinese government report on June 1, that revealed a slowdown in the country's manufacturing numbers, worsened investor anxiety regarding McDonald's growth potential in Asia. These concerns also dragged down shares of McDonald's primary rival, Yum Brands (YUM: Charts, News), which depends on China for nearly half of its revenue. McDonald's operates 1,500 restaurants in China, while Yum owns 4,600. To combat shrinking margins and persistent price increases due to food inflation, McDonald's has introduced more value lunch items and a new chicken burger to its Chinese menus, and plans to roll out a new "value-priced dinner" in the coming months.

Oak Brook, Illinois-based McDonald's is expected to report its weakest quarterly earnings in three years on July 23. Analysts are projecting a gain of 2.5% for the company. The company is facing contracting margins in China - its company-operated margin declined from 17.5% in the prior year's first quarter to 16.9% in the most recent one. Don Thompson, who will take over as CEO in July, acknowledged that the company was "seeing challenging economic conditions, with slow growth in China."

The performance of American fast food in China is largely dependent on the growth of the Chinese middle class, which is still rising. RBC Capital Markets analyst Larry Miller commented, "While China is slowing to some degree, it's still a profitable market for fast-food chains." He ranks both McDonald's and Yum with a "buy" rating.

In addition to China's slowdown, negative same-store sales from Japan, still reeling from the effects of last year's tsunami, weighed heavily on the region's numbers. A strong U.S. dollar - seen as a safe haven in uncertain times - also cut into sales.

The negative news from Asia overshadowed some positive numbers elsewhere in the world. In May, same-store sales in the United States rose 4.4%, while Europe gained 2.9% - coming in higher than analyst expectations. Both negate concerns that the American economy is slowing, and that Europe is teetering on the brink of a recession. In the United States, new breakfast products such as blueberry banana nut oatmeal and beverages such as the Cherry Berry Chiller have boosted sales considerably. In Europe, McDonald's posted stronger-than-expected numbers in the United Kingdom, France and Russia. The company depends on Europe for 40% of its global revenue. Australia, a small but growing market, also posted higher-than-expected sales.

Although McDonald's is lagging the market now, Wall Street analysts still favor the long-term growth prospects of the company. While earnings growth is estimated to dip to 2.5% in the second quarter, most analysts see a rebound to 6.6% in the third quarter, and an average of 6.2% earnings growth for fiscal 2012. Analysts forecast 10.5% earnings growth in fiscal 2013.

Shares of McDonald's trade at 14 times forward earnings with a 5-year PEG ratio of 1.6. The stock pays a quarterly dividend of 70 cents per share, which has been steadily increased since its inception in 1988.

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Published on Jun 15, 2012
By Leo Sun
Leo Sun
Leo Sun is a freelance finance writer and position trader. He focuses on a combination of value and momentum investing, with a strong interest in the trading philosophies of Warren Buffett and Peter Lynch. Leo also has experience writing articles to help small business owners acquire loans and manage their finances. He regularly contributes to the Stock of the Day analysis.

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