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McDonalds - profits fall behind analyst expectations

Nicholas Hyett | 23 October 2019 | A A A
McDonalds - profits fall behind analyst expectations

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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: 219.71 | Buy: 219.84 | Change 2.71 (1.25%)
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Third quarter revenues rose 3% at constant exchange to $5.4bn, with global like-for-like (LFL) sales up 5.9%. Operating profit rose 2% to $2.4bn, slightly behind market expectations due to higher operating expenses.

McDonald's announced an 8% increase to its quarterly dividend to $1.25 per share.

The shares fell 3% following the announcement.

View the McDonald's latest share price and how to deal

Our View

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

That's because in many ways 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 - albeit buying their supplies from McDonald's plc.

Shifting more business 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 positive for profits.

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.

Across the globe around half of stores have been kitted out so far, with all the US stores due to have had their makeover by the end of 2020. That should provide long hanging fruit in the search for growth, which helps explain why the shares change hands for 24.4 times expected earnings, a sizeable premium to the longer-term average of 18.5.

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 2.4% in 2020, and analysts are forecasting growth in the future, although there are no guarantees.

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Third Quarter Results

LFL sales growth reflects a 4.8% increase in the US, 5.6% growth in the International Operated Segment and 8.1% in International Developmental Licenced (where the McDonald's brand is licenced to third parties). Systemwide sales - which includes sales by franchisees - rose 5% to $26bn.

Operating expenses rose 2% to $3bn, as the lower costs associated with running fewer restaurants directly were offset by increases elsewhere.

The company returned $2.4bn to shareholders in the quarter, bringing the cumulative total returned to $22.5bn since the start of 2016. McDonald's is currently working through a plan to return $25bn to shareholders over the 3 years to 2020.

Find out more about McDonald's shares including how to invest

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 disclosure for more information.