McDonald's Misses on Lower Comps

Oakbrook, Illinois-based McDonald’s Corporation (MCD - Analyst Report) posted second quarter 2012 earnings of $1.32 per share, missing the Zacks Consensus Estimate of $1.38 as well as the year-ago level of $1.35 per share. The lower-than-expected result was due to lower comparable-store sales across all regions and unfavorable currency impact.

However, excluding the adverse effect of currency translation of 7 cent in the reported quarter, earnings grew 3.0% year over year.

Quarter Highlights

McDonald’s, one of the nation's largest chains, reported revenues of $6.92 billion during the quarter, flat year over year but below the Zacks Consensus Estimate of $6.94 billion. Excluding the negative impact of foreign currency translation, revenues grew 5.0% year over year.

Revenues from company-operated restaurants fell 1% to $4.67 billion while the same from franchise-operated restaurants jumped 2% to $2.24 billion. Total operating income contracted 2% to $2.16 billion.

McDonald’s global comparable sales continued to remain positive for the quarter, but were below the year-ago level. The company witnessed a 3.7% upside in global comparable sales (comps) for the quarter, lower than the year-ago level of 5.6%.

The company witnessed downward moves across all three geographical segments, namely the United States, the U.K. and APMEA, on a yearly basis. While the United States and Europe delivered similar performances, the Asia/Pacific, Middle East and Africa (APMEA) region was the main dampener in the quarter.

In the United States, comps grew 3.6% versus 4.5% in the prior-year quarter. The comps in the quarter were backed by strong customer demand for core offerings like breakfast menu and the McCafe beverage line-up. The everyday value-menu was the other major contributor in the quarter. Additionally, the upside in comps was driven by restaurant refurbishments. Operating income for the segment rose 2% during the quarter.

Europe saw growth of 3.8% as opposed to 5.9% in the year-ago quarter. The growth was backed by stronger performance in the U.K., France, Germany and Russia. The efficient mix of premium as well as value-menu and a restaurant reimaging program were responsible for the quarter’s performance. However, operating income for the segment slipped 3%, but was up 8% in constant currency.

In APMEA, comparable sales nudged up 0.9% versus 5.2% in the year-ago quarter. A somewhat healthy performance was palpable primarily in China and Australia. However, Japan continued to post sluggish results. A continued focus on daypart value options, variety in menu as well as locally relevant items drove the segment. However, operating income declined 2%, but inched up 1% in constant currency.

Franchised restaurant occupancy expenses and selling, general and administrative expenses escalated 1% and 5%, respectively, and company-operated expenses remained flat year over year.

Financial Position

In the second quarter of 2012, McDonald’s returned $1.6 billion to its shareholders through share repurchases and dividend payments.

Outlook

The company expects comps to remain positive for the month of July as well, but lower that the second quarter.

Our Take

The fast-food chain’s comps performance in the reported quarter was below par, as the company is caught up with difficulties like implementation of austerity measures in Europe, increasing commodity costs in the US and decelerating growth in Asia. With the focus on value proposition along with less pricing power, margins will likely be affected going ahead. In addition, high levels of unemployment are projected to continue in the foreseeable future.

However, McDonald’s has so far efficiently endured the recent economic turmoil in Europe. Moreover, company’s revitalization initiative, the “Plan to Win” program, aiming to sustain growth by increasing restaurant visits, providing everyday value, innovating new menu items, as well as re-imaging restaurant along with market campaigns will continue to bolster the company’s growth.

Consequently, the company has a Zacks #4 Rank (short-term Sell rating). We also reiterate our long-term Neutral recommendation.

One of McDonald’s primary competitors, Yum! Brands Inc. (YUM - Analyst Report) recently reported second quarter 2012 adjusted earnings of 67 cents per share, missing the Zacks Consensus Estimate of 70 cents. Earnings nudged up just 1% year over year. A hike in tax-rate, inflated cost structure, especially in China and settlement of a California employment lawsuit at Taco Bell were responsible for the underperformance of earnings per share.