McDonald’s Reports Weak Results As Dollar Meals Hurt Profitability

McDonald’s Corporation (NYSE:MCD) announced its first quarter results which failed to enthuse investors. Total revenues increased 1% to $6.60 billion while operating income was down 1% to $1.95 billion. Net income remained flat at $1.27 billion. Global comparable sales were down 1% as the management blamed weak consumer confidence globally for tepid sales. ^[1]

Quarterly comparable sales fell for the first time in a decade although that was not totally unexpected since sales in the previous year quarter were unusually high. A warmer winter last year resulted in better than expected sales, so these results come on top of a high base since McDonald’s global same-store sales were up 7.3% in the first quarter of 2012. Same-store sales should begin to normalize once the effect of a warmer winter subsides (i.e. April onward).

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.

See full analysis for McDonald’s Corporation

I’m Not Lovin’ It

McDonald’s is facing a plethora of challenges including shrinking company-operated margins and growing discontent among its franchisees. ^[2] Margins are getting squeezed primarily because of the product mix that the customers are choosing. Input costs are expected to rise at a moderate 1.5-2.5% in the U.S. and 2.5-3.5% in Europe. Thus, it’s not the commodity cost that’s the real threat to the company’s profits, instead, more and more customers are choosing lower-priced products which have thinner margins.

Due to flagging comparable sales in the second half of 2012, McDonald’s had upped its focus on value meals such as the Dollar meals to boost footfalls. Recent additions to the Dollar menu include the Grilled Onion Cheddar burger and the Hot ‘n Spicy McChicken. The move has helped to restore sales partially, but they’re coming at the cost of margins. For the quarter, the company-operated margins were down 130 basis points to 16.2%. Going forward, margins will remain weak, at least in the near term, till the company is successfully able to attract customers to indulge in pricier items.

Margins of its franchised restaurants were relatively stable at 81.7% vs. 82.3% in the previous year quarter. McDonald’s franchised margins generally tend to remain in a narrow range since the company doesn’t have to incur food and labor expenses for such restaurants.

However, the franchisees are complaining about the excessive reliance on value meals. The costs of commodities have to be borne by the franchisees and value meals are hurting their margins. On the other hand, rising sales benefit McDonald’s since its revenues are a percentage of franchisee sales. This conundrum of finely balancing sales vs. margins is something that remains a challenge for the company in the near term.

We have a $92.80 price estimate for McDonald’s, but we are in the process of revising our estimates to incorporate the latest results.

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

1. MCD 8-k [↩]
2. Franchisee survey shows growing discord at McDonald’s, April 16, 2013, chicagotribune.com [↩]