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McDonalds - COVID-19 hits Q1 as expected

Emilie Stevens, Equity Analyst | 30 April 2020 | A A A
McDonalds - COVID-19 hits Q1 as expected

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McDonalds Corporation Com Stock US0.01

Sell: 188.73 | Buy: 188.85 | Change 1.01 (0.54%)
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McDonald's first quarter revenues fell 5% to $4.7bn and operating profits dropped 17% to $1.7bn. As recently announced, coronavirus is having a significant impact on McDonald's and as expected total comparable sales were 3.4% for the first quarter, masking a 22.2% decline in March.

Around 75% of McDonald's restaurants across the world remain operational, with most adapting to focus on Drive-thru, Delivery, and/or Take-away only.

McDonald's has taken a number of measures to improve liquidity, including increasing its cash position to $6.5bn through debt, suspending the buyback programme and reducing this year's capital expenditure programme.

The shares dipped slightly in pre-market trading.

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Our View

A third of the world is in lockdown - that makes dining a very tricky industry to be in at the moment.

McDonalds' business model looks more like a property company than a restaurant chain. It owns most of its buildings and franchisees run the restaurants, which should provide it with some shelter.

While service is disrupted, knocking both the franchised restaurants' and McDonald's earnings (who receive a share of the cut) - it's the franchisees who are on the hook for most of the restaurant running costs. In recent years this has been good news for operating margins and profits, with higher sales spread over relatively fixed cost base. But as revenues take a hit in the near term, this effect could unwind.

However, first quarter results show that while insulated McDonald's is not immune. While three quarters of restaurants are operational, most are operating on a limited basis, with smaller menus and Drive-thru or takeaway only. As a result sales took a hit in March, and revenue and profits for the quarter followed suit.

While it's too soon to call, if the pandemic and economic fallout are severe and large numbers of franchisees are forced out of business, McDonalds's protection will only go so far. For now, the group is on the front foot and is deferring cash collection for certain rents and royalties to help out embattled franchisees. This isn't a long term solution though, so we'll be watching this closely.

With earnings uncertain, the balance sheet comes into play.

The group has access to $3.5bn in undrawn credit and recently raised an additional $6.5bn of new finance. That's a substantial amount of cash to have access to, and adds a much needed layer of protection.

McDonald's net debt was around 3 times annual cash profits on 29 January. While that's higher than we'd like, it's not unmanageable. It's something to keep an eye though, as an extended hit to profits could see even the best balance sheets come under strain.

To preserve cash McDonald's is pausing the roll out of new openings and restaurant makeovers. That's not an existential problem, but is a shame because it's a key part of the group's competitive strategy, and McDonald's has been feeling the heat in the key US market.

In light of the challenges, McDonald's said it remained confident in its resilience but is not complacent. We think that's a fair assessment. However, until we've come out the other side, the dining industry will continue to take a hit. The longer the disruption the bigger the dent, so things could still get worse before they get better.

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First Quarter Results

In the first two months of 2020 comparable sales rose 7.2%. Reflecting growth of 8.1% in the US, 8.5% in International Operated Markets, driven by a rise in the number of customers and average bill value. In the International Developmental Licenced market (where the McDonald's brand is licenced to third parties) comparable sales rose 3.7%, impacted by restaurant closures in China.

However, in mid-march McDonald's experienced a significant decline in results, as governments and consumers responded to the pandemic. That led to a fall in comparable sales of 22.2% in the month. Sales in the US fell 13.4%, International Operated Markets dropped 34.7% and International Developmental Licenced sales fell 19.4%.

Within the $4.7bn revenue for the quarter, company operated restaurants contributed just over $2bn, 10% lower than the same period last year and revenue from franchised restaurants dropped 4% to $2.6bn.

These declines together with a 3% rise in total operating costs rose to just over $3bn, saw profits drop 17% and earnings per share fall to $1.47, down from $1.72 last year.

As at 30 April nearly all McDonald's restaurants in the US are operating through Drive-thru, Delivery, & Take-away only. It's a similar story overseas but with 45% remaining operational - largely reflecting European closures. 80% of international licensee restaurants are operational, China's nearly fully operational again but is seeing reduced demand. Just about all Japanese restaurants are open and 65% are in Brazil.

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