McDonald’s Earnings: Take the Cautious Bear Route

by Joseph Hargett | October 18, 2013 9:50 am

McDonald’s Earnings: Take the Cautious Bear Route

McDonald’s (MCD[1]) is slated to release its third-quarter earnings report bright and early Monday morning, and Wall Street will be looking to see if customers are still “lovin’ it.” McDonald’s earnings are slated to come in at $1.51 per share on revenue of $7.34 million — a mere 3% rise over the same quarter last year.

That said, slow year-over-year growth is just the tip of the iceberg for the problems plaguing McDonald’s stock[2]. MCD investors can only hope that Monday’s report will put those concerns to rest.

Sluggish economic conditions have not played into McDonald’s hands as some might have expected. Instead of the benefiting from increased patronage due to its low-priced offerings and dollar menu, MCD has joined Walmart (WMT[3]) as a whipping post for the problems associated with low-wage, low-benefit jobs[4].

Back in July, MCD stepped in a public relations nightmare when it suggested a budget for employees that included them getting a second full-time job[5]. Meanwhile, recent reports indicate the wages offered at fast-food jobs could be costing the government roughly $7 billion per year in public assistance funding[6].

The news couldn’t have come at a worse time for McDonald’s, as the public was already whipped up over the events leading up to and through the recent government shutdown.

But the situation could be grow much worse for McDonald’s stock down the road if a new Goldman Sachs study has any teeth to it. Specifically, based on a survey of 2,000 consumers, McDonald’s ranked last among 23 fast-food chains in terms of food quality, healthfulness and customers’ willingness to pay more for the food.

McDonald’s “is the restaurant consumers are least likely to recommend to their friends/family,” Goldman analyst Michael Kelter said in a research note to investors[7].

The question that McDonald’s stock investors will ask Monday morning is, “Has all this vitriol affected McDonald’s bottom line?” Judging from the company’s sentiment backdrop, many analysts and investors believe it has.

For starters, McDonald’s earnings whisper number for Q3 arrives at $1.49 per share — two cents shy of the consensus estimate. Meanwhile, in the brokerage community, analysts have doled out just 12 “buy” or better ratings, compared to some 15 “hold” or worse ratings. Furthermore, the consensus 12-month price target rests at $105 per share — a premium of only about 10% to Thursday’s close at $95.47.

In other words, brokerage firms aren’t expecting much growth out of McDonald’s over the next year.

Options traders are also leaning toward a bearish outlook for MCD. Including weekly options, the stock’s October/November put/call open interest ratio arrives at 0.82, with puts nearly in parity with calls among options set to expire within roughly the next month.

Taking a closer look reveals that peak call open interest totals 8,563 contracts at the weekly Oct 19 97.50 strike, with another 7,663 contracts at the 100 call strike in the same series. The next most populous call strike is the Nov 97.50 strike, where 7,245 contracts reside. On a side note, there are some 2,400 calls at both the Nov 95 and 100 strikes.

On the surface, the combined activity at these three strikes suggests that there could be a call butterfly spread at work here. Without more intimate data, this would be impossible to confirm, but it’s an interesting bullish strategy, nonetheless.

On the put side, peak open interest resides at the Oct 19 95 strike, totaling 5,810 contracts. Another 4,303 contracts reside at the Oct 19 92.50 strike, while the next most popular put is the Oct 26 strike, with open interest of 4,671 contracts.

Despite all this speculation, weekly Oct. 19 options implieds are only pricing in a potential McDonald’s earnings move of about 1.3%. This would place the upper bound near $96.12, while the lower bound lies at $94.29.

MCDChart 300x247 McDonalds Earnings: Take the Cautious Bear Route
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From a technical standpoint, MCD could be in dire straits.

McDonald’s stock has drifted more than 6% low since peaking in mid-April, breaching the psychologically important $100 mark in the process. Additionally, MCD’s 50- and 200-day moving averages have formed a bearish cross — a technical formation that could signal additional weakness.

Options traders looking to position themselves ahead of the quarterly McDonald’s earnings report might want to consider a Nov 92.50/95 bear put spread.

At the close of trading on Thursday, this trade was offered at 78 cents, or $78 per pair of contracts. Breakeven lies at $94.22, while a maximum profit of $1.72, or $172 per pair of contracts, is possible if MCD closes at or below $92.50 when November options expire.

As of this writing, Joseph Hargett did not hold a position in any of the aforementioned securities.

Endnotes:
  1. MCD: http://studio-5.financialcontent.com/investplace/quote?Symbol=MCD
  2. problems plaguing McDonald’s stock: http://investorplace.com/2013/09/mcd-mcdonalds-stock/
  3. WMT: http://studio-5.financialcontent.com/investplace/quote?Symbol=WMT
  4. the problems associated with low-wage, low-benefit jobs: http://investorplace.com/2013/10/minimum-wage-mcjobs/
  5. included them getting a second full-time job: http://www.latimes.com/features/food/dailydish/la-dd-mcdonalds-budget-guide-20130716,0,6051133.story
  6. roughly $7 billion per year in public assistance funding: http://www.businessweek.com/articles/2013-10-15/mcdonalds-low-wages-come-with-a-7-billion-side-of-welfare
  7. research note to investors: http://blogs.wsj.com/corporate-intelligence/2013/10/15/losing-the-taste-for-mcdonalds/

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