By: Melvin Pasternak of Street Authority
I have to admit it: McDonald's (NYSE: MCD) is not one of my favorite fast-food restaurants.
As I age, I am increasingly concerned about the effect diet has my health, so I try to eat lots of fruits and vegetables and avoid foods high in salt and fat. True, you can find some relatively healthy options at McDonalds if you choose wisely. However, if you indulge regularly in high-fat, sodium-rich hamburgers and fries, it can lead to an increased risk for Type 2 diabetes and heart disease, among other things.
My beef with the chain goes beyond its food, though. The company also uses way too much packaging from my point of view -- a sin it shares with many of its fast-food brethren. For anyone with a sensitive environmental conscience, what gets dumped into the trash can at the end of a McDonald's meal causes added distress.
My complaint with McDonald's stock goes beyond my dislike for the restaurant. With the broader market reeling from the effects of the Greek debt crisis and the massive sell-off in Chinese stocks, I believe McDonald's may be on the brink of a major correction. As a result, it is setting itself up as a highly profitable short trade.
The Outlook Is Dim For McDonald's
There are several big-picture reasons McDonald's stock could be in trouble. To start, changing consumer tastes are demanding healthier offerings across the globe. The result: a weak fundamental outlook, as seen in falling earnings and revenue forecasts.
More specifically, many research studies show American consumers are demanding healthier food choices. Sales at competing, healthier fast-food restaurants are increasing, while McDonald's U.S. sales are slumping. The most recent same-store sales report showed a decline of 2.2% for May, despite the company's attempts to lure customers with promotions like "Dollar Drink Days."
The Asian market also seems to be tiring of the Golden Arches. Consider Japan -- the chain's second largest market, trailing only the United States. McDonald's Japan just reported weak June numbers. Sales dropped 23.4% -- news that came on the heels of discouraging May numbers showing a 22.2% sales decline.
McDonald's China is also suffering sharp declines. In 2014, Chinese media uncovered a scandal surrounding tainted meat. Today, many Chinese remain wary of the burger chain.
Once again, these trends are reflected in the stock's fundamentals. For the upcoming quarter, analysts project weakening demand will result in revenue dwindling from $7.2 billion a year ago to just $6.4 billion -- a fall of 10.3%.
The full-year outlook is also negative. Analysts expect revenue will fall 9%, dropping from $27.4 billion last year to $25 billion this year.
Unsurprisingly, this is expected to impact the bottom line. For the upcoming quarter, analysts predict earnings will fall more than 11%, going from $1.40 to $1.24 per share. Analysts expect a year-over-year drop for all of 2015 as well.
How To Profit From The Weakness
Based on the weakening fundamental outlook, traders seem wary. Just look at the chart below.
Twice this year, shares challenged but could not break resistance just above $100.
This level was first tested in February and again in May. The pattern sets up a potential double top, a highly bearish reversal pattern that often leads to a large decline.
The key level to watch is the mid-$93 level, which the stock tested in April. If MCD falls below $93, the double top will be completed.
However, traders could get an even earlier warning that all is not well technically, as the stock is now at a particularly important junction. It is clinging to the uptrend line from its February low, which currently intersects around $95.20.
Directly below -- at $94.78 -- is support marked by the 30-day moving average. If this band of support is broken, shares could drop as low as $86.12 before finding important historical support.
One factor that may keep McDonald's afloat is that it pays a dividend of $0.85 a quarter, which comes to $3.40 a year. On a forward basis, that equates to an annual yield north of 3.5%.
Still, that yield is the only bright spot for McDonald's right now -- and it's not a guarantee. The dividend payout ratio is quite high at almost 72% of projected 2015 earnings ($4.74 per share). If the chain cuts its dividend because of weakening earnings, it will snowball the aforementioned problems since the stock will be less attractive to investors seeking safety and yield.
Based on the fast-food company's bearish technical and fundamental outlook, I'm shorting the iconic burger chain.
Recommended Trade Setup:
-- Sell MCD short at the market price
-- Set stop-loss at $100.34, just above current resistance
-- Set initial price target at $86.35, just above major support, for a potential 11.6% gain by the end of 2015
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