McDonald’s Corporation (NYSE:MCD) reported weak quarterly earnings on Friday hit by a combination of factors such as a strong US dollar, increased one-time expenses and softness in the global economy, which negatively impacted the consumer spend in the quarter. Total revenues remained flat at $7.2 billion whereas net income declined 3% to $1.5 billion. Currency effect shaved 4 percentage points from the top-line as well as the bottom-line. 
Global comparable sales could only manage to grow 1.9% in Q3, down from 6.6% in the same quarter previous year. Year-to-date, McDonald’s comparable sales are up 4.1% which is actually pretty good given the global state of the economy. However, the company pointed out that comparable sales is trending negative for October so the macroeconomic overhang may not be over yet. The regional breakdown of the comparable sales is as follows:
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U.S. – 1.2%
Europe – 1.8%
APMEA (Asia, Middle East and Africa) – 1.4%
Others – 5.5%
Surprisingly, Europe continues to post moderate comparable sales growth figures despite the fact that its economy is the most precarious of the lot. Europe has benefited from refurbished outlets and an extension of restaurant timings. In APEMA, China outperformed the broader region with a 3.6% comparable sales growth helped by the breakfast slot, which the company mentioned was growing in double digits.
Thrifty and Margins
Comparable guest count was up 2.2% in the first nine months of the year which is in line with our expectations. Therefore, the weak comparable sales data can be attributed to the fact that a greater proportion of consumers are opting for value meals such as the dollar menu in the U.S. or the 100 yen menu in Japan.
Overall margins were hit by higher one-time General & Administrative (G&A) expenses such as investments related to IT upgrade and Olympic sponsorship fees, estimated to be in the region of $100 million. The U.S. margins were also impacted by higher labor expenses due to the 2011 HIRE Act payroll tax credit which could not be offset by weak comparable sales numbers.
Gross margins will be under pressure in the fourth quarter as well since the company expects the commodity inflation to be in the region of 3.5% to 4.5% in the U.S. and around 2.5-3.5% in Europe. McDonald’s expects commodity inflation to cool next year so margins should stabilize going forward. Reported company-operated margins declined 90 basis points to 19.1%.
Franchised margins remained more or less stable since they are less prone to changes in food, labor and occupancy costs. The reported franchised margins for the quarter stood at 83.4% versus 83.7% in the same quarter last year.
We have a $96 price estimate for McDonald’s, but we are in the process of revising our estimates to incorporate the Q3 earnings.Notes: