A few days before, I had written a bearish article on McDonald's (MCD, Financial) with a view that the stock can be avoided for 2015. On January 23, 2015, the company released its 4Q14 results and the results back my bearish view for McDonald's. This article discusses the key aspects of the company’s results and the outlook provided by McDonald's for 2015.
In terms of regional analysis, in the U.S., fourth-quarter comparable sales decreased 1.7% and operating income declined 15%. Europe's fourth quarter comparable sales declined 1.1% and operating income decreased 14% (down 6% in constant currencies). APMEA's fourth quarter comparable sales decreased 4.8% and operating income declined 44% (down 40% in constant currencies). The sharp decline in APMEA was primarily due to the impact of the supplier issue on sales and profitability in China, Japan and certain other markets. For other regions, the decline in comparable sales and operating income was due to negative guest traffic.
In my view, the negative guest traffic is the biggest issue for McDonald's in 2015 and I believe that this issue will continue to impact the company’s sales and profitability prospects. The evidence comes from the company with January 2015 comparable sales expected to be negative and McDonald's also expecting results to remain pressured in the first half of the year.
Therefore, it is clear that there will be no strong bounce back in the company’s results and outlook for 1H15 and the decline in comparable restaurant sales will continue. This will put pressure on the stock price and ensure that there is no upside for the stock while the downside depends on the extent of negative comparable restaurant sales reported.
The biggest concern for me is the point that even beyond 1H15, McDonald's might not be well positioned to deliver strong sales. The company’s strategy of customizing the menu, increasing advertisements and providing a healthier menu still remains to be tested and it will be tested in a very competitive market. Therefore, I will not buy McDonald's until there is a clear rebound in sales coming from very positive guest traffic. That is not seen on the horizon.
Another point that is worth mentioning is that the company’s capital expenditure for 2015 has been reduced to $2 billion, which is the lowest level in five years. The reason is that the company is targeting fewer openings amid challenging market conditions. It remains to be seen how the new openings translate into growth in 2015 and beyond. However, the company is going conservative and I believe that the capital expenditure will remain prudent until there is a strong indication of improvement in comparable store sales.
From a shareholder value creation perspective, McDonald's outlined a target of $18 to $20 billion for the period 2014-16 in terms of potential returns to shareholders through dividends and share repurchase. While this value creation initiative will continue, the key issue is the impact of this value creation will be more than offset by other negatives. Therefore, at this point of time, the focus should be on EPS growth through sales growth and margin expansion than EPS growth through share repurchase.
From a valuation perspective, McDonald's does not seem expensive considering a FY15 forward PE of 15.9. However, the point is that sentiments will remains depressed in terms of earnings growth and in my view; investors can avoid the stock even at current valuations.
