Despite concerns about the core lunch business, we believe that – for now – the company continues to execute so well in other day parts that we remain positive on all three durations (TRADE, TREND, TAIL). Yesterday’s results were impressive but the stock’s reaction tells us how high expectations are for MCD.
There is so much to admire about McDonald’s top line performance, but there is just one issue that keeps nagging me and I keep thinking when it will become a bigger focus of the street attention.
I have been thinking about the core lunch business declining for a year now. But the growth in breakfast, snacks and nontraditional day parts has overshadowed this issue. At the company’s analyst meeting last November the issues around lunch were obvious but did not seem to cause much concern for analysts and investors.
On yesterday’s earnings call there were two questions that were asked that got at the issue and the company side-stepped the topics on both occasions. The first question was on “building capacity” in the restaurants and the second was on traffic trends. Don Thompson answer was telling on this issue, as he talked about the growth in nearly every day part but lunch.
In response to a questions on consumer movement Don Thompson said that there were a couple of things that the company focuses on. “…One of which is day part analyses. So as we look at day parts like evenings and breakfast, do we see – are we seeing more momentum in some of those day parts, which typically starts to, if you correlate that with some of the unemployment numbers and some of the hired numbers, the new job numbers, it tends to help us a little bit. We see a little bit of movement. I mean, our evening day parts were pretty strong comp and breakfast has been a pretty strong comp for us.”
What about lunch? After all, that is the core business. To figure out the bear case on when MCD sales trends are going to slow, it’s important to keep in mind capacity constraints at breakfast and the afternoon and evenings. Knowing that lunch is an issue, a breakdown of MCD comp performance is telling of how much the company is reliant on the non-traditional day part.
FY11 Comp = +4.8%
Price = +3.0%
Guest Count = +3.3%
Implied mix = -1.5%
Today’s traffic drivers are causing the decline in the mix of business, but that is more than offset by the growth in incremental traffic. For the time being none of this matters, but it will. The question is when?
Turning to yesterday’s results, when a company beats on EPS, margins, and prints global comps of 9.6% for December, the stock only goes down if expectations were very high. For the time being, though, we remain positive on MCD.
The phrase, “expectations are the root of all heartache” comes to mind. McDonald’s traded down yesterday despite producing a stellar 4Q. EPS came in at $1.33 versus consensus $1.29, McOpCo restaurant margins came in at 18.7% versus 18.6%, and same-store sales easily exceeded expectations in December. Please see below for the same-store sales and quadrant charts updated for today’s results.
In terms of the top line in the U.S., which remains the company’s most important market, we believe that the company will continue to take market share from competitors. The company is growing internationally and China, one focus of expansion, saw 4Q comps come in at +15.6% with double-digit traffic. From an investment standpoint, the company’s 12 month yield of 2.57% and global diversification attracts the “flight-to-quality” investor. That said, we do not believe that the fundamental story is over for McDonald’s.
While it is impossible to know exactly what brought the stock down today, there are concerns around G&A, FX headwinds, and interest expense. We believe that these factors are transient. The increase in G&A is related largely to items particular to 2012, some of which will in fact help sales in during the year and beyond, and we expect strong top-line momentum to continue in early 2012. Until we gain more clarity on real fundamental issues coming to the fore, we remain positive on MCD.