The restaurant sector encountered headwinds that lead to worse-than-expected second-quarter earnings. Following Yum! BrandsandChipotle, McDonald’s was the latest restaurant chain to miss estimatesfor the quarter. But should investors buy or sell?
Reviewing the restaurant companies that have already reported earnings, Raymond James' senior Restaurant analyst, Bryan Elliott, said it is clear that consumer spending is slowing globally. He predicted the slowdown to continue in the near-term.
“We’ve got food inflation risk rising with the drought in the Midwest and the big jump in grain prices,” Elliott said. “It’s going to be a tough environment for restaurants for a while.”
Until the 2013 crop takes shape, Elliott told investors to expect mid to high single digit food inflation.
In the Q2 earnings conference call, McDonald’s CEO Don Thompson attributed the decline in sales to a weak global economy and low consumer confidence. He cited increased competition in the U.S. as well as pressure in the euro zone as major headwinds.
Sales in Asia were also down. Thompson said the Chinese consumer is currently very cautious, and more Japanese consumers are choosing to eat at home.
Despite the recent decline in the restaurant sector, analysts are still listing McDonald’s as a buy.
Since most of the valuations in the sector are not stretched, Elliott does not anticipate significant downside risk.
“These are very good cash-flow businesses,” Elliott said. “We expect McDonald's to raise their dividend 10 percent in September.” With the dividend sitting just above $3, Elliott predicted McDonald’s would gain stronger yield support and become more appealing.
Matthew DiFrisco, managing director and senior restaurant analyst at Lazard Capital Markets, also has a buy on McDonald’s. “We think it’s a double-digit earnings grower in 2013,” he said. While acknowledging that there will be headwinds in the second half of 2012, DeFrisco said the stock is adjusting and the outlook looks strong.
Starbucks is also one of DeFrisco’s top picks. “We think they have a lot of strong growth opportunities,” he said. “They are managing their capital toward the higher margin business segments, consumer products group, and they are also making a lot of headlines with their new product extensions.”
DeFrisco said that the key to a successful restaurant is new roll-outs that signal stability and long-term growth. He cited Starbucks’ introduction of Evolution Fresh and fruit drinks as promising product releases that will likely yield growth.
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