MCD – Loss in Translation

I fully appreciate that MCD’s currency issues have no implication on the company’s ability to generate free cash flow, but it will impact perception. And the current perception is that MCD can grow EPS at a double digit rate for the next five years. Those expectations need to come down.

MCD posted another month of strong comparable sales growth across the board yesterday with total company same-store sales up 7.7% in November. In today’s environment, it is hard to find weakness in a U.S. number up 4.5% and APMEA up 13.2%. MCD’s systemwide sales number of up 1.9%, however, was negatively impacted by foreign currency rates which reduced the reported number by 7.7%. MCD’s sales and operating income growth has benefited from currency translation every quarter since 3Q06 on both a total company basis and in Europe. The magnitude of this positive currency impact has grown rather steadily since that period until 3Q08. And in 3Q08, even with the slight contraction, currency still boosted consolidated and Europe’s reported EBIT growth by 5% and 9%, respectively.

Fourth-quarter 2008 will mark the first quarter since 3Q06 where that favorable currency trend reverses and actually hurts MCD’s reported results. From the chart below, it is easy to see that the currency impact has turned sharply negative in October and November, thereby reducing reported systemwide sales by 4.5% and 7.7%, respectively. According to the company’s guidance, “earnings are affected by changes in foreign currency exchange rates, particularly the Euro and the British Pound. If the Euro and the British Pound both move 10% in the same direction compared with 2007, the Company’s annual net income per share would change by about 8 cents to 9 cents.” MCD stated as a point of reference that the weighted average exchange rate used to translate the company’s income statement in 4Q07 (U.S. Dollar rate for one unit of foreign currency) was $1.45 for the Euro and $2.04 for the British Pound. Based on those numbers, both currencies have moved in the same direction in excess of 10% quarter-to-date on a YOY basis and should cost MCD about $0.10 in EPS. Although MCD’s same-store sales remain healthy, this currency headwind in 4Q and going forward could remove some of the company’s past quarters built-in earnings cushion.