McDonald's Earnings Report Is Beginning of the End for Restaurant Bull Market

NEW YORK (TheStreet) -- Shares of McDonald's (MCD) are roughly flat Tuesday morning after the company -- a bellwether for restaurant stocks -- reported first-quarter earnings that missed estimates.

McDonald's stock -- which has risen 3% this year -- was recently trading at $99.50, down 17 cents.


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While first-quarter revenue of $6.3 billion met analysts' average estimate, earnings per share came up 3 cents short at $1.21.

Revenue was up just 1.4% versus the same quarter last year, while net income fell 5.1%. While global same-store sales rose 0.5%, they fell 1.7% in the U.S. Given that the company generated about 31.5% of total revenue from domestic locations last year, the drop in U.S. same-store sales is a concern for the market.

McDonald's, arguably one of the best-run companies in the business, has a market capitalization of $99 billion, three times that of its closest competitor, Yum Brands (YUM).

McDonald's also boasts among the highest net profit margins among publicly traded restaurant companies, at close to 20% during 2013. The stock is widely followed by analysts, and earnings shortfalls, especially in this environment, may be a harbinger of things to come for the industry as a whole.

MCD Chart MCD data by YCharts

Following a multiyear bull run for restaurant stocks, the operating environment is becoming more challenging. The competition in the restaurant business has always been fierce, but there are other factors at play that may help derail the restaurant bull market.

Given the run-up in beef prices, and other commodity costs, restaurants that have not passed rising costs along to the consumer yet, may ultimately have to do so. It is unclear whether consumers will be willing to pay more. Those chains that hold the line on prices will see profit margins slip, and stock prices may follow.

Pressure on labor costs may also be an issue, given the push for a higher minimum wage. That would hit the restaurant industry hard, given that labor is typically the largest expense.

Add to this the valuation factor -- the average restaurant stock trades for more than 35 times trailing earnings -- and there's ample reason to be cautious.

As for McDonald's, today's earnings shortfall doesn't spell doom for the fast-food giant. The stock trades at less than 16 times 2015 estimates, a small price to pay for 20% profit margins.

If the restaurant run-up is indeed on its last legs, there are plenty of other restaurant stocks that will likely be hit much harder. More on that in a future column.

At the time of publication, the author held no positions in any of the stocks mentioned.

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

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