Recent first quarter results released by McDonald’s showed progress versus previous quarters. For example, comparable-store sales growth was 5.5% on a global basis. This figure was boosted by the company’s international performance, with international lead territories such as the U.K. and Germany recording 7.8% growth and foundational markets such as Japan and Brazil delivering a rise of 8.7%. These figures compare favorably to the U.S., where comparable-store sales moved 2.9% higher.
Versus the first quarter of 2017, earnings per share were up by 17% to $1.72, with the company’s operating margin increasing by 590 basis points to 41.7%. The performance represented the eleventh consecutive quarter of positive comparable sales and the fifth consecutive quarter of positive guest counts on a worldwide basis, with the latter figure moving 0.8% higher.
Growth potential
Since its results were released on April 30, the McDonald’s stock price has moved 6% lower. This compares unfavorably to the performance of the S&P 500, which is up by 1.9% over the same time period.
Yet the company’s financial performance could be catalyzed by the continuation of its refranchising programme. When its current CEO took charge in 2015, 81% of its restaurant base was franchised. That figure stands at 92% today, with the company targeting a long-term figure of 95%. This could boost the company’s earnings-per-share growth over the medium term, since franchising has a positive impact on profitability. It means that employee costs are shifted from the company to the franchisees, with rental income being more profitable than lower-margin food sales.
The company also has growth potential from its increasing usage of self-service kiosks in restaurants. They are being rolled out at a rapid rate in the U.S., with 1,000 restaurants being upgraded each quarter as part of $2.4 billion earmarked for capital expenditure this year. Self-service kiosks not only reduce labour costs for the business, but also equate to higher spend per customer. According to the company, when people dwell more at a self-service kiosk, they end up spending more. As a result, comparable-store sales in the U.S. could be catalyzed by the roll out.
Food delivery remains another area that could transform McDonald’s future financial performance. The company’s growth in this area has not required major capital investment, since its deal with Uber has allowed it to expand delivery from 200 restaurants at the start of 2017 to 11,500 locations worldwide. Already, delivery is contributing to comparable-store sales growth, with order sizes from delivery being one and a half to two times the size of in-store orders by value. With the online delivery market growing in size by 20% in the last five years, it could be a key growth area for the business in future.
Risk
One potential risk facing the company is a decline in guest count in the U.S. It dropped in the first quarter, with competition among rival brands being high – particularly in the breakfast segment. Rivals such as Starbucks have increasingly focused on winning a larger share of the lucrative breakfast market. This has provided consumers with greater choice, and has ultimately contributed to falling guest numbers for the company.
Menu innovation, however, has been able to protect the company from what has been a flat sales performance in the wider industry. Its $1 $2 $3 value menu has been relatively successful in attracting customers, with the aim being trade-ups to more expensive menu items. Alongside this, the company is continuing to innovate. For example, it has released a new fresh beef quarter-pounder, while also marketing other premium burgers and sandwiches.
Additionally, the company is seeking to reduce selling, general and administrative expenses by $500 million by the end of 2019. As part of this cost-cutting drive, staff layoffs seem likely. This would tie in with its $2.4 billion capital expenditure programme, with self-service kiosks having the potential to cut costs and generate higher comparable-store sales in the U.S., having already done so in locations across the globe.
Verdict
McDonald’s has multiple growth catalysts which could push its stock price higher. The continued focus on refranchising could offer higher margins over the medium term, while the roll out of self-service kiosks has already proven to be successful in a variety of markets. This could help to improve U.S. comparable-store sales, while a focus on innovation and its value menu could lead to an improving guest count.
Furthermore, in the long run the company’s delivery opportunities may continue to expand. Growth in online delivery in recent years has been strong, and this trend looks set to continue in future. Therefore, after a recent pullback, the stock could offer value investing appeal.
