There wasn’t too much to get excited about in the McDonald’s quarter. June comps were much better from a headline perspective than we were expecting but that was primarily due to an underestimation of the calendar shift benefit. Sales growth is expected to decelerate, on a sequential basis, in July from June. The company’s commentary on macro headwinds and, in particular, consumer confidence in various markets, was sobering. Below we go through a quick earnings recap and offer some comments on the outlook for the company. We remain cautious on McDonald’s; on 6/20 we wrote a note titled, “MCD – JUNE LOOKS LIKE IT’S GOING TO BE A ROUGH ONE”, that discussed our view on McDonald’s prospects for June and the rest of the summer. Our stance is unchanged; we believe that fundamental and macro headwinds are likely to pressure MCD’s stock during the summer months.
McDonald’s reported 2Q12 EPS of $1.32 versus $1.38 consensus expectations. As the table below shows, besides some leverage gained over “other” expenses, the company failed to meet the Street’s expectations for 2Q on all major earnings-related metrics. The Consensus Metrix consensus was looking for 2.2% EPS growth. Importantly, management stated that the FY12 constant currency operating income growth rate will be at or somewhat below the 6-7% long-term operating income growth rate.
June/July Comparable Sales
Global comparable sales for the month of June came in at 4.4% versus 2.1% consensus. The calendar shift, of 1.0-2.9% varying by area of the world, was greater than we expected. Global comparable sales in July are expected to be positive, according to the company, but less than the second quarter results.
United States comparable sales for June came in at 2.9%, marginally ahead of consensus. We underestimated the impact of the calendar/trading day shift impact on June results. On a calendar-adjusted, two-year average basis, the underlying trend – at best – was sequentially flat from May to June. Management highlighted core menu favorites and new additions to the McCafé as key sales drivers.
Europe remains a difficult market for McDonald’s with consumer confidence waning across the region, according to management commentary. Italy remains a particularly difficult menu for McDonald’s. Austerity measures and other wage-depressing factors like payroll fees are a drag on McDonald’s business in Europe.
APMEA was impacted by slowing economic conditions in China, Australia and Japan. Breakfast continues to grow as a day part in China, now constituting more than 9% of sales.
The outlook for McDonald’s is fraught with uncertainty. As the company said today, “persistent unfavorable economic conditions are weighing on consumer sentiment and spending”. Other headwinds as we move through the second half of the year include high G&A expenses, including investments in technology, Olympic sponsorship, and the company’s worldwide convention.
A primary concern for us is the 3% of price that MCD is running in the U.S. with CPI for Food Away from Home running at roughly the same level. Should the economic environment deteriorate further, the company may have to sacrifice margin to maintain guest counts.
The commodity outlook for McDonald’s was lowered to 3.5-4.5% from 4.5-5.5% prior. Given recent movements in the commodity market, however, we would not expect that number to decline further from here.
Sentiment has plenty of room to come in although we wouldn’t anticipate a rush for the exit; in 2008, McDonald’s was one of the safest names to own. As things stand today do not think the stock represents a compelling buying opportunity until it gets closer to $80.