McDonald’s Q1 Earnings: Slower Recovery Efforts in Japan Hurts Comparable Sales

McDonald’s (NYSE:MCD), the leader in the fast-food industry, reported poor numbers in its first quarter earnings report, released on April 22. The company’s global comparable sales declined 2.3%, due to negative customer traffic in all the major operating segments. McDonald’s consolidated revenues declined 11% year-over-year (y-o-y) to $5.9 billion, whereas its operating income declined 28% y-o-y to $1.38 billion. In the first quarter, the company faced strategic charges worth $195 million in operating income, resulting in a negative impact of $0.17 to EPS. As a result, the company’s net income dropped 33% y-o-y to $811 million. ^[1] This is the first earnings report under the new CEO, Stephen Easterbrook, who took over the position on March 1.

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Comparable Store Sales Decline, As Japan Unit Struggles

McDonald’s global comparable store sales declined 2.3%, with an 8.3% decline in comparable store sales in Asia-Pacific, Middle-East and Africa (APMEA), and a 2.6% decline in the U.S.  Poor performance in the APMEA region had the biggest impact on the company’s net earnings, with Japan and China’s growth declining 32.3% and 4.8%, respectively. Last year’s supplier scandal in China still had a negative impact on Japan’s performance, with consumer perception still a topic of concern. Although, the situation in China is improving, it is still on a slow track. In the first quarter, APMEA’s operating income declined 80%, due to restaurant closings. The only highlight in the APMEA region is the company’s significant improvement in Australia, which posted positive comparable store sales for the third consecutive quarter. McDonald’s Australia is still in the early stages, and the company is making efforts to improve the menu across many categories, such as beverages, burgers, and salads.  Also, it is improving the value meal platform and other features such as home deliveries and the sitting environment.

In the domestic market, McDonald’s comparable store sales were down 2.6%, despite a slight improvement in the breakfast market share. McDonald’s performance in the breakfast daypart was offset by sluggish growth in all other dayparts, resulting in a net decline in the customer traffic. In the U.S. market, the company is making efforts to revamp its menu by including locally relevant taste and by introducing innovative value meal offerings.

In Europe, McDonald’s comparable sales declined 0.6%, primarily due to harsh economic conditions in Russia, partially offset by positive growth in the U.K. In France and Russia, the company is facing operational headwinds, as consumer trust is declining and macroeconomic conditions remain poor. Germany is one of the markets where McDonald’s sees potential growth in the coming years.  Last month, the company opened a 500-seat flagship restaurant in Frankfurt.

For the second quarter, the company expects the global comparable sales to follow the same trend, at least in the month of April.

Decline in Operating Income

McDonald’s consolidated operating income declined 28% in the first quarter of the fiscal 2015, partially due to $195 million of strategic charges accounting for restaurant closings and other management actions. These include:

1. $85 million incurred as assets write-offs related to the company’s re-franchising activities, including selling of some of the restaurants to development licensees.
2. $72 million as charges incurred in the activity related to closings of 350 under-performing restaurants in Japan, China, and the U.S. Among these, 130 restaurant closing are in Japan. Apart from these closings, the company plans another 350 global closings in 2015.
3. $38 million as charges incurred in restructuring to create a more efficient organization in the U.S.

As a result of these one-time expenses, the company’s net income dropped significantly by 33% y-o-y to $811 for the first quarter. McDonald’s 81% of the restaurants are franchised, and hence, franchise margin is the most important and largest driver for the company. However, this quarter, the company’s franchise margins declined $152 million to $1.6 billion. On the other hand, global company-operated margin declined 180 basis points to 14.3% in the first quarter, due to high commodity and labor costs. Higher beef prices resulted in a 2% increase in the U.S. commodity costs. As a result, McDonald’s raised the menu prices in the U.S. by 2%. Despite the counter measures, McDonald’s EPS for the quarter was down $0.37 (or 31%) to $0.84.

Negative Sales Forecasts For McDonald’s Japan

In the first quarter report, the company mentioned that the company’s management will announce the turnaround plan, or guidance for the full 2015 fiscal year, on May 4. However, on April 16, 2015, McDonald’s Japan released its consolidated earnings forecast for fiscal year 2015. The company’s Japan unit expects a 14.4% decline in system-wide sales (combined sales of company-operated and franchised restaurants), and expects a 10% decline in its consolidated sales. As a result, consolidated net income loss is forecast to be roughly 38 billion yen. ^[2]

The Japan unit plans to renovate close to 230 restaurant locations by changing store interiors in fiscal 2015. On the other hand, new store openings will be reduced to 20, half of that in 2014. The company estimates a net 20 billion yen ($165 million) as the cost of remodeling and new store openings. And for that purpose the company took out loans of 22 billion yen from lenders such as Mizuho Bank.

As the year progresses, we will see how McDonald’s recovery unfolds, and how investors react to McDonald’s turnaround plan to be announced on May 4.

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1. McDonald’s Q1 2015, earnings call transcript [↩]
2. Earnings forecast for Fiscal year 2015 and business revitalization plan [↩]