Are McDonald’s Rising Sales Coming At The Cost Of Margins?

McDonald’s Corporation (NYSE:MCD) global same-store sales fell 1.5% in February. The results initially might paint a worrisome picture, but a closer look reveals that the situation might not be as bad as it seems.

Firstly, last year February had an extra day since it was a leap year. Excluding the effect of the extra day, McDonald’s same-store sales were up 1.7%. ^[1] Secondly, a warmer winter in the U.S. last year resulted in better than expected sales. McDonald’s sales in the first three months of 2012 were unusually high so these results come on top of a high base. For example, same-store sales were up a whopping 11.1% in February last year. The reported same-store sales figures should improve once the winter passes. Sales in the U.S., from where the company derives about 40% of its profits were down 3.3% but flat when adjusted for the extra day.

Comparable sales, or same-store sales growth, 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.

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Margins Getting Squeezed

Beginning in the fourth quarter of 2012, the company has upped its focus on lower priced value meals (such as the Dollar menu) to address faltering sales. Recent additions to the Dollar menu include the Grilled Onion Cheddar burger and the Hot ‘n Spicy McChicken.

Although the results of the last couple of months signal a turnaround, McDonald’s excessive reliance on value meals to resuscitate flagging sales is the reason behind our conservative valuation for the stock. Operating margins for the company-reported restaurants were already down 90 basis points to 17.8% in the fourth quarter of 2012. ^[2] Value meals generally have lower margins and are offered by the company to attract more customers with the hope that they will spend more on other expensive (and more profitable) items.

New menu introductions will be critical for McDonald’s to recoup some of its lost margins. The company has added Fish McBites to its menu this year and plans to debut new beef sandwiches and chicken entrees soon. ^[3]

We have a $92.80 price estimate for McDonald’s, which is about 5% lower than the current market price.

Understand How a Company’s Products Impact its Stock Price at Trefis

1. MCD Investor Relations [↩]
2. MCD8-k [↩]
3. MCD Earnings Transcripts [↩]