Value investing isn't just about being able to identify which stocks are the cheapest. It's also about weeding out cheap-looking stocks that are potential disasters. Such is the case with
Folks, don't get me wrong. On the surface, Mickey D's looks like a bargain. I mean it has a stellar operating history, and it trades at less than 15 times forward earnings. But looks can be deceiving.
Just take a gander at the company's latest financials and you'll see what I mean. Even a better-than-expected second-quarter earnings report can't hide the fact that the underlying numbers are softening. Meanwhile, the company keeps throwing money at share buybacks -- and the stock keeps falling.
In its latest report, the company goes out of its way to point out that total "operating margin dollars (at its restaurants) increased $26.3 million for 2% for the quarter." Sounds good, but pointing out this dollar figure is another way of saying the actual operating margin -- that is, operating income divided by sales at company-owned restaurants -- is falling. Second-quarter operating margins declined by 20 basis points from last year, to 15.2%.
In other words, total operating income is rising only because the company added 1,214 total locations over the past year. So the real profitability of each store is actually declining. That's not hard to believe, because sales in the bread-and-butter domestic business are in decline. While second-quarter systemwide sales -- including both company-owned and franchised restaurants -- rose 2% to $10.4 billion, U.S. revenue crept up just 1% and U.S. same-store sales actually fell 1.6%.
Unless the company continues to add new stores at a breakneck clip, it's only a matter of time until total revenue starts heading south. But opening more and more stores is prohibitively expensive, especially when new stores are offering such poor returns. Instead, the company may choose to pony up more advertising dollars, but that would pinch margins and depress earnings.
The second quarter also benefited from a lower tax rate. That is good because the company is giving less money to Uncle Sam, but it's bad because it means that earnings benefited from an event that investors can't count on quarter after quarter. Considering the positive press Mickey D's received for "beating estimates by a penny," it's worth thinking about.
Meanwhile, the company keeps throwing money at stock buybacks, but the stock keeps falling. During the second quarter, the company repurchased 16.6 million common shares at an average of $27.97 apiece. In the first quarter it bought back 11.9 million shares at around $27.77 a share.
But what's the stock price now? Under $24 -- which means the buyback program has cost the company about $109 million in paper losses so far this year. And that's an awful big waste of money if you ask me.
Bottom line: McDonald's still makes a decent burger. But its financials aren't strong enough to make the stock a solid value play.
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In keeping with TSC's editorial policy, Glenn Curtis doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Curtis welcomes your