MCD - Looking Forward to Thursday

There is a lot to love about MCD – it’s a unique global brand with a strong business model that generates lots of cash!

It’s not cheap trading at 9.4x our NTM EBITDA estimates, but carries a 3.4% dividend yield!  The company’s value positioning during the economic downturn has allowed the company to capture more market share than I ever thought possible.  

Going forward, in order for the company to continue to capture more market share, it is clearly dependant on its US specialty coffee initiative and premium products to not just drive comps, but help mitigate margin decline from the significant discounting the company is doing. 

I remember a time when the McDonald's management team could not do anything right!  While most of those individuals are now gone, right now the investment community believes that this management team can do no wrong!  Either extreme is probably not right, but the truth is somewhere in the middle.

It’s not out of the realm of possibilities that senior management has “misread” the market or it could be an unfortunate case of bad timing.  Given the size of the organization, once a new product initiative is determined to be a “go,” it’s nearly impossible to stop the process if the timing is off.  Rolling out a $4 sandwich and $3.50 cup of coffee into the teeth of a 10% unemployment rate could be a case of unfortunate timing.

Most QSR operators that are focused on “high-end” products are seeing soft sales and are not taking additional market share because people are not spending money on expensive items.  Burger King is the poster child for corporate missteps and it recently had to change its strategy to focus more on discounting because its premium products failed to drive traffic.  I contend that McDonald’s current product strategy is not focused on its core market – family and value-minded customers. 

While it might take some time to manifest, MCD’s focus on specialty beverages and its premium Angus burger could result in the company’s losing market share versus street expectations of continued market share gains. 

To that end, I am not surprised by the recent slowdown in US same-store sales on a 2-year average basis.  I would expect the sequential slowdown to continue in Q2 based on my estimate of 3.9% US same-store sales versus 4.7% in Q1.  I also expect more of the same in Q3.

Systemwide sales should continue to come down on a reported basis, though the currency headwind appears to have peaked in April when the negative impact on sales hit nearly 10%.  Based on July currency levels for the Euro, the British Pound, the Australian dollar and the Canadian dollar, which collectively represent approximately 70% of the Company’s operating income outside the US, foreign currency rates should become less of a headwind in Q3 on a YOY basis and prove beneficial in Q4.

All in, MCD should report EPS of $0.96 (consensus at $0.97).  The tax rate and nonoperating income/expense line, which includes gains and losses on company investments, are extremely volatile quarter to quarter and difficult to forecast so I would not be surprised to see a penny of upside/downside from such items.  Operating margins should improve nearly 200 bps in the quarter as I would expect continued SG&A cost discipline to offset a slight decline in restaurant margins. 

Talking about things to love, MCD should easily hit its FY07-FY09 goal to return $15-$17 billion to shareholders through share repurchases and dividends.  Unfortunately, MCD is such a cash machine that investors have become accustomed to such shareholder returns.  MCD’s stock price will react to top-line momentum, largely in the US, and I think that momentum is slowing.  The company will have a difficult time lapping its 6.7% US same-store sales comparison in July even with all of the coffee it is giving away as of late.

MCD - Looking Forward to Thursday - MCD US SSS 2Q09E

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