Fifth Consecutive Negative Comp. Sales Quarter Looming Over McDonald’s

McDonald’s (NYSE:MCD) is scheduled to report its Q2 earnings report for the fiscal 2015 on July 23, with the street expecting an EPS figure of $1.24 on $6.45 billion in revenues. ^[1] The Golden Arches has been struggling in all its geographical segments, facing financial and operational headwinds. As a result, the company’s leadership was handed over to a new CEO, Steve Easterbrook, who announced the new turnaround plans for the company after a disappointing Q1 earnings report. ^[2] Market consensus of $6.45 billion net revenues indicates a 10% year-over-year (y-o-y) decline. We can expect another sluggish performance by the company, despite the new turnaround plans and arduous recovery efforts in the affected markets, given the poor comparable store sales figures in the months of April and May. ^{[3] [4]}

After underperforming for the past 5 years, there are not high expectations for the stock. Interestingly, the first half of the last 5 years the stock matched the S&P as both rose 27%.  However, the past two and a half years has seen the S&P rise an additional 49% while MCD has only risen 7.5%. On the other hand, the last six months have been fairly stable for the stock, with much correlation to S&P’s movement during the last 4 months.

McDonald’s stock traded in the range $95-$100 during the entire second quarter, during which it rose to its then 11-month high after the announcement of the turnaround plan by the new boss.

We have a $101 price estimate for McDonald’s, which is 4% above the current market price.

See Our Complete Analysis For McDonald’s Corporation

It’s All About The Comps Game

Stiff industry-wide competition in the U.S., declining customer count, and sluggish economic conditions in Russia led to poor financial results for the company last year. The story continued in the first quarter as well, with a 2.3% decline in the global comparable sales and an 11% year-over-year (y-o-y) slump in the consolidated revenues.  (See: McDonald’s Q1 Earnings: Slower recovery effort in Japan hurts comparable sales) Another quarter with a negative comparable sales growth would be its 5^th consecutive quarter with negative sales growth, and with declining customer traffic, it seems highly probable.

For the months of April and May, the company reported a decline of 0.6% and 0.3% respectively in comparable sales growth.

The continued weakness in the Asia/Pacific, Middle East and Africa (APMEA) region, coupled with struggling operations in the U.S. due to strong industry-wide competition, might add to the company’s miseries in the second quarter’s report. Furthermore, with declining customer traffic and slow recovery efforts in Japan and China, the investors might be having second thoughts about their investments, and might shift to other stocks. With revenues of $25 billion and a market cap of $91 billion, the stock sells at 3.6 x revenues.  Competitor Restaurant Brands International Inc (NYSE:QSR), the parent company of Burger King and Tim Hortons, sells at 4.3 x revenues.  Getting the same valuation would imply almost a 20% potential increase in MCD’s stock.

Is McDonald’s Too Behind Its Competitors?

U.S. consumers are slowly and gradually shifting towards healthier, fresher, and organic food items. As a result, fast casual restaurants, who are readily catering to the new trends, are gaining market share in terms of customer traffic. On the other hand, where McDonald’s should be worried about improving its market share, it is struggling with other operational difficulties and is facing pressure on all fronts. Moreover, other new entrants in the fast food category are providing the customers with simpler and more innovative menu options. (See: A scenario that can impact McDonald’s stock price)

In the current outlook, it seems McDonald’s is lagging in this race and the question that is now being raised is how much more time will it take the company to catch up to its competitors, let alone beating them. Perhaps, the company tried to answer this query by introducing a new turnaround plan. On May 4, the company’s new CEO, Steve Easterbrook, announced the initial steps for a new turnaround plan, which included financial plans and restructuring of the company’s business worldwide. (Ref: 3) Below is the chart for Trefis estimates for the company’s revenue growth over the next 6 years:

According to the turnaround plans, starting from July 1, McDonald’s will be operating under new reporting structures, 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)

Apart from this, the company presented its new financial updates and franchising targets to improve its current conditions. The plan includes refranchising of 3,500 restaurants by the end of 2018, to make the company close to 90% franchised. Even though, the effect of this plan will be not be visible until the company’s Q3 report, the anticipated effect of investors and their reaction can probably be seen, looking at the behavior of the stock after the Q2 releases. Even a slight improvement in the comparable sales of the APMEA region and a positive guidance for the rest of the year, might provide much required support to the company’s stock price.

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More Trefis Research

1. McDonald’s, earnings estimates, Yahoo Finance [↩]
2. McDonald’s announces initial steps in turnaround plan including Worldwide business restructuring and financial updates [↩]
3. McDonald’s reports global comparable sales for April [↩]
4. McDonald’s reports global comparable sales for May [↩]