The fast-food environment is becoming increasingly more difficult to operate profitably in.
Share prices of McDonald’s (MCD 1.26%) were climbing higher despite the company missing analyst estimates when it reported its second-quarter results earlier this week. Customers have begun to push back on higher prices, which led the company to extend its $5 Meal Deal Promotion.
Let’s look at the fast-food chain’s most recent results, its long-term prospects, and why competitors generally fare worse when the company becomes more promotional.
McDonald’s reported some earnings pressure
For Q2, McDonald’s produced revenue of $6.5 billion, unchanged from a year ago. That fell short of the $6.6 billion analyst consensus. Same-store sales declined by 1%. That was below the 0.4% growth that analysts were expecting, and the first time the company had seen negative same-store sales since late 2020.
In the U.S. market, same-store sales dropped by 0.7%, hurt by lower guest counts. A year ago, McDonald’s U.S. same-store sales climbed 10.3%. Comparable-store sales in its International Operated Markets dipped by 1.1%, with France a particularly weak spot. International Developmental Licensed Markets same-store sales slipped by 1.3%, hurt by China.
Profitability, meanwhile, also fell, with adjusted earnings per share (EPS) declining 6% year over year to $2.97. That was below the $3.07 analyst consensus.
McDonald’s management indicated that consumer sentiment, especially among lower-income households, was low in most of its major markets and that people were being “very discriminating.” It expects the environment to remain challenging for at least the next several quarters.
Consumers finally appear to be pushing back against the big jump in menu prices over the past several years across the fast food industry. At McDonald’s, for example, the prices of popular items such as the Big Mac and Quarter Pounder are both up 20% or more since 2019.
To help draw in more cost-conscious customers, McDonald’s introduced its $5 Meal Deal offering at the end of June. On its earnings call, the company said it would extend the value offering at most of its locations into August, and that it was working with franchisees to extend it even longer.
The company is also looking to feature its chicken platform to help drive growth. This includes its classic McNuggets, and newer items such as its McCrispy and McSpicy sandwiches. It noted that the chicken category is twice the size of the beef category globally.
Image source: Getty Images.
Is it time to sell the stock?
McDonald’s is undeniably experiencing some pressure at the moment after years of benefiting from fast food and outsized inflation coming out of the pandemic. However, when the fast-food environment turns more promotional, the company has traditionally come out better than most of its competitors. The reason is that, given its size and scale, it tends to have more adjustment levers to pull related to buying power and marketing might.
As McDonald’s starts to lean more into value, I’d expect more competitive pressure to fall on other fast-food companies like Jack in the Box, Yum Brands, and Wendy’s. Fast-casual chains that cater to higher-income customers, such as Chipotle Mexican Grill, should be less affected.
From a valuation perspective, the stock trades at a forward price-to-earnings (P/E) ratio of under 20. Historically, it often trades at a trailing P/E of 24. This shows that the stock should be able to increase in price over time if it continues to grow and maintains its historical P/E average.
MCD PE Ratio (Forward 1y) data by YCharts.
Over time, McDonald’s stock should be a winner and come out of this environment in solid shape. However, I think the overall fast-food environment is likely to be much less favorable than it has been over the past several years when the entire industry was benefiting greatly from big price increases.
As such, I’d prefer to remain on the sidelines with McDonald’s and other traditional fast-food stocks. With people pushing back on price increases, the companies in the space could be more affected by industry headwinds such as wage hikes and food inflation. Minimum wages continue to rise, while prices for beef are likely to remain elevated given tight supplies associated with smaller cattle herds in recent years.
The environment is beginning to shift for the industry, and now is not the time to jump in and buy the stock.
Geoffrey Seiler has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Chipotle Mexican Grill. The Motley Fool recommends the following options: short September 2024 $52 puts on Chipotle Mexican Grill. The Motley Fool has a disclosure policy.