McDonald’s Earnings Preview: Value Meals, Food Costs Could Munch On Margins

McDonald’s Corporation (NYSE:MCD) is scheduled to announce its Q4 earnings on January 23, 2013. The stock has had a bumpy 2012, going as high as $101 in the initial part of the year before retreating to $84 in November. The company has struggled to post the desired same-store sales in the second half of 2012, but the figure turned red for the first time in nine years in October. Things improved in November with same-store sales rising 2.4%. ^[1] McDonald’s will announce the December sales growth in its upcoming earnings.

Same-store sales growth is an important parameter to gauge a restaurant chain’s performance since it only includes restaurants open for more than a year. The sales of newly opened restaurants are unusually high or low and can distort the overall revenue/store figure.

Margins Under Pressure

In this quarter, gross margins will be under pressure since the company expects the commodity inflation to be in the region of 3.5% to 4.5% in the U.S. and around 2.5-3.5% in Europe. Food expenses account for roughly one-third of the sales. McDonald’s expects commodity inflation to ease next year so margins could stabilize going forward if this is true. ^[2] The U.S. margins might also be impacted this quarter by higher labor expenses due to the 2011 HIRE Act payroll tax credit.

Franchised margins generally remained stable since they are less prone to changes in food, labor and occupancy costs. However, boosting the same-store sales is a priority since McDonald’s earns royalty as well as rental income as a percentage of the total franchisee sales. Hence, the better the sales, the higher the margins you can expect for the franchised restaurants.

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Tepid Top Line Growth

Comparable guest count was up 2.2% in the first nine months of the year. Therefore, the weak comparable sales data suggests that customers aren’t spending as much as McDonald’s would like them to. To cater to the more price sensitive consumers, McDonald’s had turned its attention to the less expensive value meals. Continued focus on this could cause the margins of its company-operated restaurants to tighten since these tend to be less profitable (but high volume at the same time).

Furthermore, a strong dollar could erode McDonald’s top line since the company derives more than 65% of its revenues from international markets. In the previous quarter, currency shaved off 4 percentage points from the top line as well as the bottom line.

We have a $93.60 price estimate for McDonald’s, which is about 5% higher than the current market price.

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1. McDonald’s November Restaurant Sales Beat Expectations, December 10, 2012, cnbc.com [↩]
2. MCD 10-Q [↩]