McDonald’s Weak Comparable Sales Weigh On Margins

McDonald’s Corporation (NYSE:MCD) announced a tepid set of results, bogged down by weak comparable store sales and unfavorable currency conversions. Total revenues grew 1% to $7.1 billion while net income rose 4% to $1.4 billion. McDonald’s posted growth of 1% in its same-store sales. ^[1]

The weak macroeconomic environment in Europe and the negative impact of a weak yen in Japan are hurting sales. Moreover, the management pointed out that the results for the remainder of the year are “expected to remain challenged.” McDonald’s shares dipped 2.5% after the earnings release.

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

Profitability Hurt

For the second quarter, the reported company-operated margins declined 50 basis points to 17.7%. McDonald’s derives almost 40% of its sales from Europe and a weak economic climate in the region does not bode well for the company’s profitability. Furthermore, an excessive reliance on value meals such as Dollar meals is hurting the restaurant chain’s margins in the U.S. For 2013, we expect the company-operated margins to decline 40 basis points due to weak comparable sales.

We expect the cost of raw materials to rise at a moderate rate of 1.5-2.5% in the U.S. and 2-3% in Europe while other expenses such as selling, general and administrative expenses are expected to remain flat.

The company’s franchisee margins were under pressure due to a weak yen. McDonald’s has about a tenth of its stores in Japan and a weak yen translates back to a fewer dollars, thereby impacting the margins negatively. 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.

Global Expansion On Track

McDonald’s has more than 33,000 restaurants globally of which about 80% are franchised. The company will be spending a whopping $3.1 billion in 2013 to add 1,200 new stores and refurbish 1,600 of its existing ones. McDonald’s still has a low penetration in China, India, Russia and even Eastern Europe and the restaurant chain will be looking to bolster its presence in developing markets. ^[2]

Increasing westernization, fueled by rising disposable incomes, is boosting the demand of fast food chains in emerging markets. Despite its ubiquity, we estimate that McDonald’s be able to add 900-1,000 new restaurants annually for the next few years.

We have  revised our price to $99 price estimate for McDonald’s, which is in line with the current market price.

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1. MCD 8-k [↩]
2. MCD Earnings Transcripts [↩]