McDonald’s Disappointing Run Continues; Margins Decline Again

McDonald’s Corporation (NYSE:MCD) reported a weak set of numbers, rounding off what has overall been a disappointing year for the company. Total revenues for the quarter rose 2% to $7.09 billion while the operating income remained flat. Net income in the fourth quarter stood at $1.40 billion, or $1.40 per share vs $1.38 per share in the previous year quarter. ^[1] McDonald’s CEO, Don Thompson, stated that comparable sales for January are expected to be flat, citing that severe winter is likely to result in fewer footfalls.

We have a $97 price estimate for McDonald’s, in line with the current market price. We are in the process of revising our estimates in order to incorporate the latest earnings.

Sales Continue To Remain Weak

McDonald’s same-store sales declined 0.1% in the fourth quarter, mainly due to fewer guest counts. For the full year, same-store sales rose 0.2%. McDonald’s made several additions to its menu in 2013, but none of them had the impact that the company hoped for. Some of the items introduced last year were Chicken McWraps and Mighty Wings. In addition, the Dollar Menu was also expanded to ‘Dollar Menu & More’ to include some of the higher priced items. ^[2]

McDonald’s management consistently blamed the weak consumer sentiment in the U.S. as the reason why the company is posting tepid sales. However, a number of other restaurant chains such as Chipotle Mexican Grill, Dunkin’ Donuts and Panera Bread have all posted strong sales figures in 2013, so blaming the economy sounds like a weak excuse.

Comparable sales, or same-store sales, is an important measure to gauge a restaurant’s performance since it only includes the restaurants open for more than a year and excludes the effect of currency fluctuation.

Margins Down Again

During the fourth quarter, margins of the company-operated restaurants declined 60 basis points to 18.2%. The contraction in margins was primarily due to weak sales and an overall product mix geared towards the lower-priced menu products such as the Dollar Menu. McDonald’s has been trying to lure customers to try the pricier items for a while now but the company hasn’t been too successful. As mentioned before, the items added in 2013 failed to enthuse customers. Some of the higher priced items were aimed to not only pep up sales but also boost margins.

Margins of franchised restaurants also declined 60 basis points to 82.4%, primarily due to weak performance in Asia & Middle East. A tenth of McDonald’s franchised stores are in Japan and the yen devaluation witnessed in 2013 put a downward pressure on the overall profitability.

Franchising is a low revenue, high margin business since the company derives only a fraction of the franchisee sales and does not incur operational expenses such as labor, occupancy or cost of raw materials. However, weak franchisee sales are detrimental to McDonald’s in the long run since it lowers the company’s bargaining power. Low sales could nudge franchisees to pressurize McDonald’s to lower its royalty and rental rates.

Store Addition To Continue

During 2013, McDonald’s increased its global store count by 949 stores. Despite disappointing sales, McDonald’s feels it is under-represented in international markets. In 2014, the company plans to spend $2.9-3 billion, to add 1,000-1,100 stores and refurbish 1,000 stores globally. ^[1] McDonald’s is looking to bolster its presence in regions of China, India, Russia and East Europe, where the restaurant chain is sparsely present and has an opportunity to grow.

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1. MCD 8-k [↩] [↩]
2. McDonald’s sales miss as fewer customers visit its restaurants, January 23, 2013 [↩]