Refranchising Efforts To Pressure Revenues But Drive Margins For McDonald’s

McDonald’s (NYSE:MCD) is set to report its first quarter results on April 30, wherein a decline in revenues is expected, but the earnings are anticipated to rise at a healthy 14% rate. The fall in revenues is a result of the refranchising of its restaurants that the company has been undertaking for a couple of years. The company’s long-term goal is for 95% of McDonald’s restaurants to be owned by franchisees, and at the end of FY 2017, this figure stood at 92%. This strategy has resulted in cutting costs for the burger giant, and has led to an improvement in margins, and consequently, the earnings. This is expected to continue in the first quarter.

We have a $184 price estimate for McDonald’s, which is higher than the current market price. The charts have been made using our new, interactive platform. The various driver assumptions can be modified by clicking here, to gauge their impact on the earnings and price per share metric.

Factors That May Impact The Results

1. Positive Industry Environment:  The overall restaurant industry environment has been positive for the quarter ended March 2018. While comparable traffic declined, comparable sales have been positive on the back of higher average checks. In March, same-store sales growth was 0.8 percent, the second-best month for restaurant industry sales growth over the last two years. While fine dining and upscale casual restaurants have consistently shown sales growth, casual dining and fast casual struggled heavily in 2017. This trend seems to be reversing, as this segment has shown signs of recovery this year, recording positive sales in the first quarter of 2018. This should benefit McDonald’s.

2. Refranchising Restaurants: As mentioned earlier, this strategy has been plaguing the revenues of the company for a number of quarters, although it has had a positive impact on the earnings. Another benefit of the franchise model is that the company can take advantage of the significant real estate portfolio it has built up over the years, and collect rent and royalty income in the years to come.

3. Value Meals: McDonald’s began 2018 by launching its $1, $2, $3 menu aimed toward its value-conscious customers. Earlier a similar program was discontinued in 2014 since it impacted margins adversely. However, this time around McDonald’s is confident that other cost efficiencies (around marketing and lower fixed costs due to higher traffic) will ensure that margins do not decline due to this value platform. The company’s promotions in 2017 around $1 meals have been successful and this menu is likely to drive growth for the company in 2018.

4. Technology Initiatives: McDonald’s is revamping its stores to create “Experience Of The Future” restaurants which will have self-serve kiosks and table service. The company’s mobile ordering and payment system continue to expand and McDonald’s is also effectively using the data captured via this platform for personalized marketing and customizations. Effective use of technology is another key growth factor for McDonald’s in 2018.

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