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For McDonald’s, Worldwide Reach Means Worldwide Problems

The Exchange

So many times in the past, the far and wide reach of McDonald's (MCD) has served it well. Now, its massive global presence is the very thing that's putting its growth in jeopardy.

McDonald's said Monday that its quarterly results took a hit from struggling economies around the world, while earnings were cut by the increase in the dollar relative to other currencies. For many people, rising bond yields in Spain and austerity plans in Greece don't mean much, often because it's esoteric commentary on something happening thousands of miles away. The McDonald's story then should help crystallize how the serious financial predicament facing so many nations can weigh down U.S. corporations.

McDonald's Restaurant

In effect, McDonald's has nowhere to hide. With more than 33,000 restaurants, less than half of which are in the U.S., the Oak Brook, Ill., hamburger seller can't avoid the fact that its biggest markets are dealing with at best tenuous economies. Had currency rates been stagnant, McDonald's would have reported year-over-year growth in operating income and earnings per share for the second quarter ended June 30. But in a world where currencies rise and fall in value, both measures dropped.

Revenue would have risen 5% excluding currency effects -- when counting exchange rates, the top line was little changed at $6.92 billion. The impact accelerated in the second quarter, when revenue lost $333 million to the strong dollar, more than four times the first-quarter total. Earnings per share declined to $1.32 from $1.35 in the 2011 quarter, taking a 7-cent deduction from currency conversions. On average, analysts were looking for $1.38.

Globally, same-store sales rose 3.7%, with Europe the best region on a percentage basis, showing growth of 3.8%. U.S. same-store sales were up 3.6% for the quarter, and in the Asia-Pacific, Middle East and Africa category, same-store sales rose 0.9%. Though not at all awful in isolation, the international figures dropped considerably from the past four quarters, when Europe's worst three-month showing was a 4.9% comp sales advance and APMEA's weakest was positive 3.4%.

Slowing Pace

In a press release, McDonald's CEO Don Thompson said the "overall results reflected the slowing global economy, persistent economic headwinds and the investments we've made to enhance restaurant operations." He added that while global comparable sales for July are expected to be positive, they are forecast to grow at a rate "less than second quarter," he said.

That's not all. On a conference call, Chief Financial Officer Peter Bensen said appears that McDonald's will end this year "at or somewhat below" its operating income growth target of 6% to 7%.

Thematically, the call focused on similar points throughout, namely the success of McDonald's breakfast items on the plus side, but lower consumer sentiment and higher commodity costs on the down side. For instance, in Europe, France and Germany have been positive contributors, but their results are being hurt by the debt problems in the EU, Thompson said. One silver lining is that even though "guest counts are down in several markets, we are faring better than the competition," he said.

Beyond Europe, McDonald's is seeing weaker consumer confidence in Australia, a slowdown in China's economy and continuing troubles in Japan, whose economy has been tepid for two decades and which more recently was left to recover from the 2011 tsunami. Thompson said the company would try to use value items (lower-priced) to get customers in to McDonald's stores, with the hope that once there, they would be convinced to trade up to something more expensive.

"This is a time for us to focus on guest count growth and market share gain," he said on the call.

For Americans, the economy at home is the one that matters, and it's generally viewed as somewhere between bad and terrible. For a company like McDonald's, the markets that make up its non-U.S. presence are even more worrisome -- Europe alone has north of 7,200 McDonald's restaurants.

Weakening Stock Price

But there are at least a handful of reasons to be positive if you're an investor, chief among them that McDonald's tends to reward its owners. "We will reinvest in the business first, and after that we will return all free cash flow to shareholders," Thompson said, adding that the company funneled $1.6 billion into dividends and buybacks in the most recent quarter. Free cash flow, FactSet says, has risen at a compound annual growth rate of 5.5%, and you can seldom have too much of that.

Shareholders who've stuck with the company mostly have been glad in recent years.  As noted in February, McDonald's was the best performing stock on Dow Jones Industrial Average (^DJI) in the past five years, and it's raised its dividend every year since the 1970s. However, the last few months haven't been as kind, as McDonald's has fallen some 10% in the past six months.

Against other large restaurant stocks, Wendy's (WEN) is the only other name of note that's declined in that span. Now at $88.97, down 2.9% for the session, McDonald's is roughly $13 below the most recent consensus analyst price target compiled by FactSet, and it's trading under the lowest single available target, $90 from Jefferies.

That's especially glaring when viewed vs. the gains of the prior two years. In 2011, the stock rose nearly 31%, and in 2010 it was up right at 23%. Both of those crushed the return of the S&P 500, but this year it trails the index by a wide margin, FactSet data show.

Changing direction isn't going to be easy. The company and its stock are to a considerable extent at the mercy of flagging global economies, and it's not going to simply pull out of the countries where it's got bases. For McDonald's, the best thing that can happen is to see some stability, much like the rest of the world.