McDonald’s Confident On Positive Comp. Sales In Third Quarter, After Beating Market Expectations In Q2

McDonald’s (NYSE:MCD) managed to just outperform market expectations in the Q2 fiscal 2015, as the company reported $1.26 EPS, beating the market expectations by $0.02, whereas the company posted revenues of $6.49 billion, beating the street estimates by $40 million. However, on year-over-year (y-o-y) performance, McDonald’s global comparable sales declined by 0.7%, making it the fifth consecutive quarter with negative comparable sales. McDonald’s consolidated revenues declined 10% y-o-y, whereas the consolidated operating income declined 16% y-o-y. ^[1]

With a new turnaround plan for the company’s business, positive guidance for the third quarter, improvement in the Asian markets, and above-expectation performance in the second quarter, the company managed to sustain the investors’ confidence in the company, for now. MCD stock didn’t show much volatility after the Q2 earnings release, as the stock traded between the range of $96 and $99 after the Q2 earnings release.

We have a $101 price estimate for McDonald’s, which is 4% above the current market price.

See Our Complete Analysis For McDonald’s Corporation

Turnaround Plan To Offer New Direction

On May 4, the company’s new CEO, Steve Easterbrook, announced the initial steps for a new financial plan and restructuring strategy of the company’s business worldwide, in a new turnaround plan. ^[2] Among all this, the prime priority of the company still remains the sustainable growth in those markets, which were badly affected due to some operational issues last year. According to the company, regaining customer’s trust and loyalty must be led by reviving the customer’s interest in the quality, hygiene, and efficiency in the services offered.

According to the turnaround plans, starting from July 1, McDonald’s will be operating under new reporting structures, as follows:

• U.S.: the company’s domestic market (40% of operating income in 2014)
• International Lead Markets: It includes the established markets, such as Canada, France, Australia, Germany, and the U.K. (40% of operating income in 2014)
• High-Growth Markets: Markets with high growth potential in terms of expansion and franchising potential. It includes China, Poland, Russia, South Korea, Spain, Italy, Switzerland, and the Netherlands. (10% of operating income in 2014)
• Foundation Markets: the remaining markets with potential to function in a franchised model. (10% of operating income in 2014)

These structural changes are already proving to be successful for the company, with each separate segment having gone through huge operational changes. Restaurants in Australia and Hong Kong are focusing more on personalization options for the burgers, whereas McDonald’s restaurants in Germany are focusing more on overall restaurant experience. On the other hand, in the U.S., where the concept of fresh and organic food products offered by fast casual restaurants is gaining popularity, McDonald’s has shifted its focus on serving hot fresh food and fast service to improve the customer experience. New organizational structure as well as positive financial growth plans might instill positive sentiments among the investors.

Q3 Comparable Sales Expected Positive, As China Recovers

Comparable sales growth remained strong in the newly formed International Lead Market segment, which includes Canada, France, Australia, Germany, and the U.K. All these high growth countries continue to perform well despite the headwinds. Introduction of Value breakfast meals and ‘Create Your Taste’ customized burgers in Australia, new breakfast menu options in the U.K., and expansion of the coffee portfolio in Canada and Germany, led to an overall increase in the customer count, and consequently, an increase in comparable sales.

Among the other markets, the company reported comparable sales of negative 3% in China. However, the company claims that higher sales restaurants in China, which account for 50% of sales, posted flat comparable sales for the quarter, as recovery efforts pick up pace in the region. Overall in APMEA (Asia/Pacific, Middle East and Africa), comparable sales declined by 4.5%, whereas operating income declined  26% y-o-y, as McDonald’s Japan still struggles with low customer traffic.

In the U.S., comparable sales decreased by 2%, as the fast food giant continues to face negative customer count in the country, driven by underperformance of the featured products and promotions, as well as stiff competition in the industry. However, the company is happy with the performance of restaurants in the Northwest region, especially in Kansas City, and is confident of the segment’s performance in the coming few quarters, as it focuses on the breakfast menu and modernization of the restaurant base.

Factoring in all the above elements, the company strongly expects to report positive comparable sales in the third quarter, driven by growth in the International Lead market segment, as well as by recovery efforts to regain customer count in Asian markets (Japan & China), after the meat scandal in 2014. An increase in average visits per restaurant, as well as an increase in average check might help the company to boost its revenue growth.

As for now, we believe that investors have no reason to doubt the company’s progress in Asian markets. The whole scenario will be clearly visible in the monthly comparable sales report in the coming couple of months. However, another bump in the path for McDonald’s might raise the skepticism  of investors, who are waiting to see if this turnaround will gain traction.

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1. McDonald’s, Q2 2015 earnings call transcript [↩]
2. McDonald’s announces initial steps in turnaround plan including Worldwide business restructuring and financial updates [↩]