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McDonalds - second quarter drop, but signs of improvement

Emilie Stevens, Equity Analyst | 28 July 2020 | A A A
McDonalds - second quarter drop, but signs of improvement

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McDonalds Corporation Com Stock US0.01

Sell: 242.42 | Buy: 242.49 | Change -0.72 (-0.30%)
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Second quarter revenue fell 30% to $3.8bn, as total comparable sales declined 23.9% in light of restaurant closures, limited menus and "dramatic" changes to consumer behaviour. A decline in operating costs of just 11%, to $2.8bn, meant operating profits were 57% lower at $961m.

Sales in each region improved throughout the second quarter as lockdowns eased, and around 96% of McDonald's restaurants are now open.

The shares fell 2.3% in pre-market trading.

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

Our View

Global lockdowns followed by social distancing restrictions have made the dining industry a very tricky place to be.

But so far McDonalds' has fared better than many. A system of drive-thrus, digital service options and natural inclination towards takeaway food have allowed most franchisees to keep trading, despite restrictions - albeit in smaller quantities. A business model that looks more like a property company than a restaurant chain - owning most of its buildings and franchisees running the restaurants - also provides some protection on the cost side.

While service is disrupted, knocking revenues for both the franchised restaurants' and McDonald's itself, it's the franchisees who are on the hook for most of the restaurant operating costs. In recent years this has been good news for operating margins and profits, with higher sales spread over relatively fixed cost base. However, it also works in reverse, and means lower revenues are having an outsized impact on profits.

While most restaurants are now operational, they're operating on a limited basis, with smaller menus and Drive-thru or takeaway only. The result has been a hit to summer sales.

We also suspect that, in reality, McDonald's is also less insulated from the operating costs of its franchisees than first glance might suggest. The group's forked out extra cash to support local marketing campaigns and is deferring cash collection for certain rents and royalties to help out embattled franchisees. However, it's still booking the revenues now. If the economy delivers a rapid turnaround that move will have provided vital support to its franchisees. If not the cash may never turn up. Clearly this isn't a long term solution, so we continue to watch it closely.

With earnings uncertain, the balance sheet comes into play. McDonald's net debt was around 3 times annual cash profits prior to the crisis and has risen as earnings take a hit. That's higher than we'd like but not unmanageable as things stand. At the end of March the group had 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 has said it remained confident in its resilience but is not complacent. We think that's a fair assessment. Its scale and business model should help it weather the dining disruption. But it's currently valued at a significant premium to the long term average, and with the impact of the current crisis on franchisees themselves unclear there's still some areas of concern.

McDonald's key facts

  • 12m forward Price/Earnings ratio: 28.4
  • Ten year average 12m forward Price/Earnings ratio: 19.3
  • Prospective yield: 2.7%

We've introduced this section in response to recent survey feedback.

Please remember yields are variable and not a reliable indicator of future income. Keep in mind key figures shouldn't be looked at on their own - it's important to understand the big picture.

Second Quarter Results

Global like-for-like sales were 39.0% lower than last year in April, 20.9% in May and 12.3% in June.

The US was the most resilient market, with comparable sales for the quarter 8.7% lower than last year - as a higher average spend was unable to offset lower customer numbers. However, the region did see particular weakness in the breakfast segment.

International Operated Markets sales were 41.4% lower than last year, as lockdowns disrupted the UK and France in particular. Comparable sales were negative in most markets bar Australia, which delivered a strong drive through performance.

In the International Developmental Licenced market (where the McDonald's brand is licenced to third parties) sales fell 24.2%, reflecting restaurant closures, Latin America in particular, and continued negative sales in China.

Within the $3.8bn revenue for the quarter, company operated restaurants contributed $1.6bn, 34% lower than last year and revenue from franchised restaurants dropped 29% to $2.1bn.

Headline operating costs declined 11% to $2.8bn. However, this includes additional coronavirus related costs, such as $200m to help franchisees marketing, $31m to pay off obsolete franchisee inventory and a $45m increase reserve for bad debts.

We expect to hear more detail on what these results mean for McDonald's cash position and balance sheet in the coming weeks. Register below and we'll send you the update.

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This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. 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.