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Tickers in this Article: MCD, YUM, CAKE
McDonald's Corp. (MCD) witnessed no upside in global comparable sales (comps) for the month of July, 2012, as against the year-ago level of 5.1% and 4.4% in the previous month. The fast-food restaurant operator witnessed a relatively downward movement in all three geographical segments namely the United States, Europe and Asia/Pacific, Middle East and Africa (APMEA) on a yearly basis, with APMEA underperforming the most. The flat performance failed to meet McDonald's expectation of achieving positive comps but less than the 3.7% increase recorded in the second quarter of 2012 for July.

In the United States, comps dipped 0.1% compared with 4.4% recorded in July 2011. The comps in the reported month were hit by the persistent economic turmoil which offset the gain from promotional activities. Further, a tough comparison owing to the successful launch of the Mango Pineapple smoothie also led to this weak result.

However, management noted that moderate customer demand for its core offerings like the breakfast menu and the McCafe beverage line-up compensated the downfall to some extent in the U.S.

Europe saw a decline of 0.6% as opposed to 5.3% growth in July 2011. Stronger performances in the UK and Russia were more than offset by a weaker show in Germany and most of the Southern European markets. German traffic remains extremely value sensitive in a cutthroat competitive setting.

The reported month's comparable sales dropped 1.5% in APMEA versus growth of 4.0% in the year-ago month. Japan continues to be a dampener in the month as the country continues to recover after last year's natural calamities and consumers are dining out less. Slowdown in China also accounted for lackluster performance in APMEA.

However, Australia put up a somewhat healthy performance in APMEA. Moreover, the adverse impact from the shift in timing of Ramadan, which fell entirely in August last year also tarnished the comps growth in this segment.

System-wide sales fell 3.2% but grew 2.3% in constant currencies in the month under review. Continued focus on daypart value options along with some premium products, variety in menu, locally relevant items and reimaging program are the strategies McDonald's is using across all regions.

Our Take

The Oak Brook, Illinois-based company's recent comps performance is discouraging for investors. Although McDonald's is trying hard to turnaround, its disappointing earnings report, decelerating same-store sales momentum, a soft economy leading to compression in margins, cost inflation, cut throat competition and currency headwinds compel us to have a bearish outlook on the stock.

The apprehension can be validated by the cut in analysts' estimates for the upcoming quarter. Over the last 30 days, 20 out of 22 analysts lowered their estimates while no upward movement was seen in that period.

Basically, the company is bogged down with difficulties like implementation of austerity measures in Europe owing to the sovereign debt crisis, increasing commodity costs in the U.S. and decelerating growth in Asia.

Although McDonald's has survived the brunt of higher social charges in Europe, presently the company has little pricing power there due to wavering consumer confidence and shrinkage in the Europe's IEO industry.

With the focus on value proposition along with less pricing power, margins will likely be constricted going ahead. In addition, high unemployment is projected to continue in the foreseeable future.  

The company is resorting to several approaches in each market with predominant emphasis on extra-value proposition. However, management noted that most of these measures are short-term and could prove detrimental to margins if exercised on a long-term basis.

Substantial exposure to international markets also makes the company vulnerable to currency fluctuation risks. Management expects foreign currency to negatively impact 2012 earnings by 21-23 cents per share mainly due to a weaker Euro.

McDonald's currently retains a Zacks #3 Rank (short-term Hold rating). We are maintaining our long-term Underperform recommendation on the stock. The company's competitors include  Yum! Brands Inc. (YUM).

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