On a very strong day for the broader indices on Friday, I noticed MCD still ended the day lower, one of only a few stocks in the S&P top 50 that was lower on Friday.
McDonald’s actually reported same store sales on Friday morning before the open, and the overall numbers were sluggish once again (+0.5% composite sales growth, Europe slightly better than expected, U.S. and Asia slightly worse). Management projected hardly any same-store sales growth over the next few months, and cited more customer interest in its cheaper (read – lower margin) menu options.
Those overall weak trends are more of the same for this restaurant giant. The fundamental headwinds have been building for years now. Here’s what I wrote about McDonald’s 6 months ago, in mid-May:
Well, Mickey D’s is showing some signs of strain, both fundamentally and technically. In fact, MCD only grew earnings by 2% in 2012 vs. 2011. Last week, MCD moved lower on Wednesday after revealing that same store sales in were lower again in April, led by weakness in China and Europe. But MCD is also having trouble dealing with increased competition from Wendy’s in the U.S.
In addition, I posted the following in our Chart of the Day post almost 3 months ago:
Of course, I’ve also been fundamentally bearish on MCD given its declining margins, increasing competition, and franchisee unrest over the past year, not to mention its high valuation relative to its fast food peers.
That franchisee unrest, particularly in the U.S., speaks to the pressure on management to keep costs under control. Franchisees are unhappy with the rising costs that headquarters is imposing on them, including higher rents and more onerous purchasing terms. Since overall revenues for the restaurant chain have hardly risen since 2011 (2% per year in 2012 and 2013 respectively), management is trying to increase earnings through cost cuts. But with gross margins already at 56% (compared to 25-50% for most of the past decade), there isn’t much fat left to cut.
Analysts are projecting 5-6% sales growth and almost 10% earnings growth over the next 2 years, in which case the stock’s 17.5x P/E multiple is not expensive. But given the overall trends and the weak earnings reports in the past 3 quarters, the numbers simply look too optimistic.
The stock has also likely underperformed in 2013 because of the higher interest rate backdrop. With a 3.3% dividend yield, a $100 billion market cap, and years of consistent earnings growth, MCD has been a preferred stock to own among the income-oriented crowd. Higher rates this year have made that investment comparison less attractive, and the stock has underperformed.
Finally, MCD’s technical situation here looks precarious. The stock has made a series of lower lows and lower highs ever since April’s all-time high of $103.70:[caption id="attachment_32392" align="alignnone" width="600"] MCD daily, 200 day ma in black, Courtesy of Bloomberg[/caption]
The stock also was just rejected at its 200 day moving average last week. The technicals indicate that a move down to the $92.50 area could be next.
With that in mind, here’s the trade:
Trade: MCD ($97.01) Buy Dec 20th 97.5/92.5/87.5 Put Fly for $1.41
- Buy 1 Dec 97.5 Put for $2.04
- Sell 2 Dec 92.5 Puts at $0.36 each, for $0.72 total
- Buy 1 Dec 87.5 Put for $0.09
Break-Even on Dec Expiration:
Profits: Between 88.91 and 96.09, make up to $3.59, with max profit of $3.59 at 92.5
Losses: Up to $1.41 between 87.5 and 88.91, and between 96.09 and 97.5, with max loss of $1.41 below 87.5 and above 97.5.
Trade Rationale: Since MCD has such a large amount of upside resistance given all of the trading that has taken place above its current level in the past 6 months, we like the entry on the short side here. Moreover, the put fly would be a double on a quick move back down to the target level of 92.5. However, if the stock simply consolidates with no move over the next few weeks, the fly would hold its value much better than a simple put spread. The upside level to watch (to potentially sell for a loss) is the September high around $99.