McDonald’s Relying On Performances in Asian Markets For A Turnaround In Q3 Results

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Can this be a turnaround quarter for McDonald’s (NYSE:MCD)? Or will the story repeat?

The stock market is expecting the Golden Arches to report a revenue decline for the fifth consecutive quarter, when the company releases its Q3 2015 earnings results on October 22. [1] From restructuring of its worldwide business to transitioning to cage-free eggs, the burger giant has been making efforts in all areas to revive its brand appeal. According to analyst estimates, it is speculated that McDonald’s will report a roughly 8% year-over-year (y-o-y) decline in net revenues. However, the EPS estimate is close to $1.27 for the third quarter compared to $1.09 in Q3 2o14. [2]

The company’s recovery efforts in Asian markets and success of its all-day breakfast initiative might have only faintly helped McDonald’s in improving sales growth in third quarter. On the other hand, McDonald’s has a sluggish y-o-y comparison with last year’s third quarter, which witnessed a significant decline in comparable sales growth due to operational headwinds in Eastern markets. (Read: Negative customer traffic & operational headwinds in Eastern markets summarize McDonald’s poor Q3 results) The question that rises among the investors is whether the recovery efforts in the impacted markets were strong enough to provide a 180 degree turn to the company’s financial situation.

We have a $99 price estimate for McDonald’s, which is slightly above the current market price.

See Our Complete Analysis For McDonald’s Corporation

Over the last 12 months, MCD stock has jumped up nearly 15% from $91 to $105, despite the decreasing revenues and continuous decline in comparable store sales. Recently, McDonald’s board-member, Miles D. White mentioned that the company is close to making a decision regarding the restructuring of its real estate assets in the U.S., and this led to a sudden spike in the stock price of the company, taking it to its all time high of $105. Credit Suisse recently upgraded McDonald’s from Neutral to Outperform, on account of improving comparable store sales growth. [3]

mcd st

Situation In Asian Markets: Still Not Up To Mark

The China scandal of 2014 provided a tremendous jolt to the company’s top-line performance. The impact was visible in the comparable store sales of APMEA (Asia/Pacific, Middle East & Africa) segment. Soon after, the company started campaigns and initiatives in the region as part of recovery efforts, which were rather ineffective in the initial months. However, later on, the recovery efforts started reaping minimal results as the APMEA comparable sales decline started slowing down.

Mcdonalds1

Since the onset of this year, the company, through strict recovery efforts, such as changes in cooking techniques to improve taste and hygiene, introduction of promotional offers, and the use of better cooking ingredients, has been trying to revive customer trust in Japan. However, the food safety scandal and supplier issues have significantly dented customers’ perception of the hygiene and quality of the food prepared by McDonald’s. McDonald’s comparable sales in Japan decreased 23.4% in June 2015 (down for the 17th consecutive month) after a 22% decline in May, indicating that the situation in Japan might not get any better in the near term, at least for the fiscal 2015. [4] The customer traffic decline in Japan slowed to just 10.4 % in June compared to a 14.2% decline in May. However, it was offset by a faster decline in sales per customer. (Read: Is Japan situation a warning sign for McDonald’s?)

The thing to remember is that McDonald’s is facing a comparison with a 3.3% decline in global comparable sales growth, and 9.9% decline in APMEA comparable sales growth. No doubt, the company is all set to post better sales growth than these numbers. However, the question is by how much? Financial performance by McDonald’s Japan in the first half is a serious topic of concern for the company. For the fiscal year 2015, McDonald’s expects its Japan unit to post a net loss of 38 billion Yen, with an operating loss of 25 billion Yen, which, in any scenario, is still a huge setback for the company. As a result, we can expect the company’s performance in the APMEA region to still be on the negative side of the spectrum, with a rather small improvement in comparable sales growth.

Trefis estimates for McDonald’s net revenue in visible in the chart below:

mcd re

All Eyes On New Segment Reporting

Earlier this year, Steve Easterbrook, McDonald’s CEO announced the initial steps for a new financial plan and restructuring strategy of the company’s business worldwide, in a new turnaround plan. [5] According to the turnaround plans, which went effective from July 1, McDonald’s new reporting structures were as follows:

  • U.S.: the company’s domestic market (40% of operating income in 2014)
  • International Lead Markets: It includes the established markets, such as Canada, France, Australia, Germany, and the U.K. (40% of operating income in 2014)
  • High-Growth Markets: Markets with high growth potential in terms of expansion and franchising potential. It includes China, Poland, Russia, South Korea, Spain, Italy, Switzerland, and the Netherlands. (10% of operating income in 2014)
  • Foundation Markets: the remaining markets with potential to function in a franchised model. (10% of operating income in 2014)

The restructuring might provide a new light to the company’s strong areas and weak zones. New organizational structure as well as positive financial growth plans might instill positive sentiments among the investors.

To summarize the whole situation, the onus is back again on the company’s performance in the Asian territories. However, the investor sentiments are totally dependent on McDonald’s fourth quarter and full year guidance. A positive guidance, as seen in the past, might drive the stock up, or at least prevent it from losing ground.  We shall see what the report from the company brings.

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Notes:
  1. McDonald’s Investor Relations, Events []
  2. McDonald’s Yahoo Finance, Analyst estimates []
  3. Credit Suisse upgrades McDonald’s to outperform; further improvements coming, favorable risk/reward []
  4. McDonald’s Japan sales down 23.4% in June []
  5. McDonald’s announces initial steps in turnaround plan including Worldwide business restructuring and financial updates []
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