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McDonalds - hearty sales growth and healthy profits

Nicholas Hyett | 26 July 2019 | A A A
McDonalds - hearty sales growth and healthy profits

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No news or research item is a personal recommendation to deal. All investments can fall as well as rise in value so you could get back less than you invest.

McDonalds Corporation Com Stock US0.01

Sell: 246.44 | Buy: 246.45 | Change 1.64 (0.67%)
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Total revenues rose 3% at constant exchange rates in the second quarter to $5.3bn, with like-or-like (LFL) sales up 6.5%. Operating profit rose 4% to $2.3bn, while earnings per share rose 7%, boosted by the ongoing share buyback programme.

The group returned $2bn to shareholders through dividends and buyback's during the quarter.

The shares were broadly unmoved following the announcement.

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Our View

There's more to McDonald's than meets the eye.

That's because it acts more like a property company than a restaurant group. Around 75% of the restaurants are owned rather than leased, and over 90% are operated by franchise partners rather than the group itself.

Shifting more business on to a franchised model has seen revenue fall from a peak of $28.1bn in 2013 to $21bn last year. However, that's only half the story. With the responsibility for maintaining and running the restaurants shifted on to its partners, operating margins have risen from 31.2% to 43%. The net effect is profits have risen.

Franchise agreements are struck on 20 year timeframes, so the model has given McDonald's an improved quality of earnings too. As a result we think the net debt position, which has swelled to around 3 times annual cash earnings following substantial share buybacks, is manageable.

With much of the day-to-day out of the way, McDonald's can focus on overarching issues across the group. That's probably for the best, as the group had been ceding ground to close competitors in its core US market.

CEO Steve Easterbrook has done a good job of getting the customers back. His recipe for success has been a simple one. Focus on upgrading the menu, increasing the digital capability and working with partners to improve the in-store experience. Think in-store WiFi, interactive boards for DIY ordering, and a new delivery offering.

Around 1,000 stores a quarter are being kitted out, but many US stores are yet to get a makeover. This should mean there are plenty of easy wins to come, which helps explain why the shares change hands for 25.4 times expected earnings, a sizeable premium to the longer-term average of 18.3.

That lofty rating puts the pressure on the group to deliver, and investors shouldn't take anything for granted. Competition across the casual dining industry is intense, and politicians the world over are increasingly focused on diet and lifestyle choices.

Overall though, we think there are reasons for optimism. McDonald's has built an incredibly strong brand over the last 70 years, and the recent changes all seem to be with the long-term health of the business in mind. The prospective yield is 2.3% in 2020, and analysts are forecasting growth in the future, although there are no guarantees.

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Second Quarter Results

LFL sales rose 5.7% in the US during the quarter, reflecting the success of the nationwide 2 for $5 mix-and-match deal. Operating profits rose 5%, helped by restructuring charges incurred in the same period last year. Without that boost operating profits would have fallen 3% as the group saw fewer gains on the sale of restaurant businesses. Total US restaurants declined by 86 year-on-year to 13,886.

The International Operated business saw LFL sales rise 6.6%, with strong results from the UK, France and Germany. Operating profits rose 8% at constant exchange rates, as revenue from franchisees increased. International operated stores increased by 180 year-on-year to 10,300.

The International Developmental Licenced segment, where the McDonald's brand is licenced to third parties for a particular territory, saw LFL sales rise 7.9%. Sales were strong across all regions. The number of franchised stores by 608 to 13,992.

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Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Thomson Reuters. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research for more information.