Strong Comps Growth In International Markets Drives A Beat For McDonald’s

by Trefis Team
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Over the past two years, McDonald’s (NYSE:MCD) has been working aggressively on several initiatives to shed its image of an “unhealthy, junk food” destination, and customize its offerings to suit changing customer requirements. These changes have started showing results, with positive comparable sales leading to a growth in profits. While the burger giant has been faced with declining revenue in recent quarters, this has been a consequence of the refranchising 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. These trends continued in the second quarter for MCD, wherein the company posted earnings of $1.99 on revenues of $5.35 billion, higher than analysts’ expectations. While U.S. comparable sales came in lower than expected at 2.6% (3% consensus), International Lead (+4.9% vs. +4.1%) and Foundational markets (+6.8% vs +5.4%) segments helped drive the overall comps growth of 4%, 40 basis points higher than anticipated.

We have a $189 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 for our interactive dashboard on MCD’s second quarter earnings, to gauge their impact on the revenue, earnings, and price per share metric.

Factors That May Impact Future Performance

1. 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.

2. 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. A higher number of items per order for $1, $2, $3 Dollar Menu transactions was one of the drivers for the comparable sales growth in the second quarter, and should continue to positively impact the results the rest of this year. Moreover, the company also introduced two for $4 breakfast in mid-March, which makes MCD more competitive in the breakfast daypart, helping ease the soft morning sales. In August, the company plans on rolling out a 2 for $5 Mix & Match deal.

3. 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 continues to expand (in 20,000 restaurants currently) and McDonald’s is also effectively using the data captured via this platform for personalized marketing and customizations. MCD has also introduced delivery in 13,000 restaurants across 60 markets, spurred by its partnership with UberEats. CFO Kevin Ozan has stated that the delivery check size is generally one-and-a-half to two times the in-store check. In a number of its top markets, delivery has increased to form roughly 10% of the total sales. Consequently, an effective use of technology is another key growth factor for McDonald’s in 2018, as it can drive the average check higher. McDonald’s also provided home delivery in many countries whose teams participated in the 2018 FIFA World Cup, such as England, Spain, France, Germany, and South Korea, which may have had a positive impact on the revenues.

4. New Launches: McDonald’s earlier launched its fresh beef burgers in select markets in the U.S. to a good response, and completed its national roll-out in Q2. CEO Steve Easterbrook noted that in the pilot markets of Dallas, “90% of customers who tried the burgers said they’d buy them again.” These premium items helped to drive the average check size higher. The company has also launched its premium burgers in other countries, such as Gourmet Creations in Australia and Mighty Angus in Canada. Increased sales of these products can help to increase the average revenue per consumer.

5. Parasite Outbreak: MCD stopped the sale of salads at 3,000 of its restaurants across the U.S. in mid-July, a day after health officials in Illinois and Iowa stated that they identified roughly 100 combined cases of cyclosporiasis apparently linked to consuming the company’s salads. While this factor will not have any effect on the company’s second quarter results, its impact may be felt in the forthcoming quarters. MCD stated that it had removed the lettuce blend from the identified restaurants and fully replenished it with a new supply, which should help to allay fears.

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