Decline In Top Line To Continue In Q4’16 For McDonald’s, As Industry Fundamentals Deteriorate

The burger mammoth, McDonald’s (NYSE:MCD), is slated to announce its fourth quarter and full year results on 23rd January, 2017. In the third quarter, the company continued to see its revenues drop. However, owing to the improvement seen in comparable sales data in the U.S. and Japan, McDonald’s stock price was seen moving higher. The upcoming quarterly results are expected to be tough for the company as the timings overlap that of the launch of the very popular All Day Breakfast in the fourth quarter of 2015. In the following note, we discuss some of the key trends that can be expected to be seen in the upcoming quarterly results.

Key Trends:

• McDonald’s is trying to reinvent itself by refreshing its menu in various locations. It launched a new version of a burger filled with Nutella in Italy, a bigger and a smaller version of the very famous Big Mac in the U.S., a Sriracha hot sauce version of the Big Mac in Columbus, Ohio, and Sriracha sauce as a dipping sauce for McNuggets and French fries. However, the initial response of customers to its various innovations has been mixed, at best. The rating agency, Fitch, believes that McDonald’s will continue to lose market share in the U.S. due to heightened competition due to the rise of specialty burger competitors and increasing breakfast competition. Making matters worse would be the decreased growth forecast of food away from home. Consequently, we may see some repercussions of this in sales numbers for the company.

• The company has continued to see strong comps in its foundational markets quarter over quarter. McDonald’s is renewing its focus to reinforce the growth potential of these international markets by introducing items to suit local tastes. The launch of a new breakfast menu in India that will feature versions for local favorites such as “Masala Dosa Brioche” and “Masala Scrambled Eggs,” in addition to traditional breakfast items such as waffles and hash browns, is an attempt in this direction.

• The main raw material used in McDonald’s burgers is beef and pork (for patties). The recent slump in the price of beef and pork is likely to help the company offset the impact of higher wages, and buoy its margins upwards. Furthermore, the Cowen Group forecasts ground beef prices to fall in the range of 10% to 15% between 2018 and 2020. This, in turn, could help the company in improving its margins over the next few years.

• McDonald’s has decided to use fresh beef patties at its restaurants in order to appeal to the health sensitive generation of millennials. However, the move may cost the company more than the savings from cheap raw material, as it may increase the wait time for customers, hampering the ability to serve large number of customers quickly. Consequently, the advantage from low raw material costs on operating margins may be reduced.

• To cut through the waiting time and manage the through-put, McDonald’s plans to introduce table service and self-ordering kiosks across its 14,200 stores in the U.S. The concept has been pilot tested at 500 locations in New York, Florida, and Southern California. McDonald’s will also introduce a mobile payments platform to make the ordering process seamless. The move is likely aimed towards the younger, more tech-savvy generations, such as millennials, who form the majority of the U.S. population. The company expects this change to provide a boost to average check size.

• To revive its business in the China/Asia Pacific region, McDonald’s has entered an agreement to sell-off some 2,200 odd restaurants in China and Hong Kong to a consortium of Carlyle and Citic Group. The company will be selling off 80% of its business in the region at a value of $2.08 billion. The deal also includes 20-year mass franchise rights. It will help McDonald’s trim its overall operational costs and preserve capital.

• The softening in company-operated revenues is expected to continue primarily due to the negative impact of refranchising, as the company-operated sales will be increasingly replaced by franchised revenues in the form of rent and royalty, based on a percentage of sales. The company aims to become 95% franchised by 2018. Most of the refranchising will take place in the company’s key future growth markets: High Growth (consisting of China and Asia Pacific) and Foundational (Japan, India, and other South-East Asian nations).

• The company will continue to focus on completion of its three-year $30 billion share buyback target, in order to support the bottom line, even as the top line continues to suffer.

• The industry-wide slowdown in the restaurant sector continued in the fourth quarter. Restaurants have now posted four consecutive quarters of declining year-over-year sales. This is due to fewer number of people eating out, and most of the consumer spending going towards big ticket purchases rather than soft goods. The following table gives a summary of the declining comps and traffic in the three months of the fourth quarter.

Have more questions on McDonald’s? See the links below.

• How Will The Restaurant Industry Be Affected By A Federal Wage Hike?
• Will McDonald’s Be Able To Revisit Its Past Glory Days?
• McDonald’s Bounces Higher On The Back Of Q3’16 Results, Future Uncertain
• McDonald’s Q3 FY 2016 Earnings Preview: Top Line To Be Weighed Down By Industry-Wide Declines
• How Did McDonald’s Japan Turn Around Its Business?
• Will McDonald’s Succeed In Keeping The Buzz Alive?
• Health Revolution: Healthy For Some, Unhealthy For Others
• How Much Upside Can Sustained Demand For “All Day Breakfast” Drive For McDonald’s?
• How Can McDonald’s Stock Price Be Affected By The Trend Towards Healthy Eating In The Next Year?
• The Continued Struggle Of The Restaurant Industry In The U.S.
• How Does McDonald’s Intend To Turn Around Its Chinese Business?
• Why Has McDonald’s Stock Price Risen 20% Over The Last One Year?
• Why Is McDonald’s Concentrating On Refranchising?
• Is McDonald’s Dependence On High Growth Markets Increasing?
• McDonald’s Versus Burger King: Whose Franchisees Perform Better?

Notes:

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