McDonald’s Q3 Earnings: Weak Sales To Weigh On Margins

McDonald’s Corporation (NYSE:MCD) is scheduled to announce its earnings on October 21. It has been a tough year so far for the fast food giant as its same-stores sales have not picked up. Shares of the company have traded in a narrow range as a strong brand name combined with the opportunity to expand further into developing markets provides downside protection to the stock even during times when the company is not doing particularly well.

McDonald’s comparable sales have only managed to rise 0.4% through August with its American sales just about offsetting the negative sales from Europe and Asia Pacific. ^[1] 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.

We have a $99 price estimate for McDonald’s, which is about 5% above the current market price.

Margins To Remain Weak

Margins of McDonald’s company-operated restaurants have been under pressure since the second half of 2012. The primary reason why the margins have deteriorated lately is because of excessive reliance on the Dollar menu, which accounts for about 14% of the U.S. sales. ^[2] McDonald’s uses this menu to attract more footfalls in the hope that customers will spend on other items once they enter the restaurant. However, the increased dependence on the dollar menu has started eroding the company’s margins.

McDonald’s recently made a plethora of menu changes to boost its sales and improve margins; however, the impact of these changes are unlikely to be felt in the third quarter earnings. Therefore, we expect company-operated margins to remain weak in the upcoming results. We expect the margins to decline 40 to 50 basis points in 2013.

Europe has seen some improvements lately; same-store sales were up 3.3% in August. Moreover, some of the recent economic data coming out of Europe points to an improvement in the region’s economic environment. Europe is the biggest market for McDonald’s accounting for about 40% of its revenues. A more robust European economy combined with U.S. menu upgrades should help margins here on.

See full analysis for McDonald’s Corporation

Yen Devaluation To Have An Impact On Franchisee Margins

Franchisee margins will be under pressure due to the yen devaluation witnessed this year. Almost a tenth of McDonald’s franchised stores are located in Japan and a weaker yen translates back to a fewer dollars. 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 these restaurants.

McDonald’s income from franchisees is a percentage of their sales. Thus, tepid franchisee sales will lead to weaker margins. An improving European economy combined with menu changes, as mentioned before, should help franchisee margins from next year. By next year, the year-over-year impact of yen devaluation will also be offset.

Long Term Potential In International Markets

Although sales have been disappointing lately, McDonald’s does see long-term potential in international markets. This is the reason why the company is spending $3.1 billion in 2013 to add 1,200 new stores and refurbish 1,600 of its existing ones. McDonald’s still has low penetration in China, India, Russia and even Eastern Europe. No wonder the restaurant chain is looking to bolster its presence in developing markets. McDonald’s has more than 33,000 restaurants globally of which about 80% are franchised.

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1. MCD 8-k [↩]
2. McDonald’s revamping ‘Dollar Menu’ to include $5 items, September 4, 2013, cnbc.com [↩]