MCD is scheduled to report 3Q09 earnings on Thursday, October 22 before the market opens. From a revenue standpoint, I think current street estimates are too bullish, and I would not be surprised to see MCD report earnings that fall a penny short of the $1.11 consensus estimate.
As I have said before, however, 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 there could easily be a penny of upside/downside from such items relative to my expectations.
From a stock performance perspective, I think investors will be more focused on recent sales trends (MCD will be reporting September comparable sales numbers by segment as well) than earnings, unless of course, it is a huge miss/beat, which is not likely. When MCD reported in line 2Q09 earnings, the stock still traded down 4.6% on the day because the company also reported below trend June same-store sales results.
To that end, I think September same-store sales growth could come in below expectations with the U.S. posting a +1% number, which would point to continued deceleration in 2-year average monthly trends (a +3.3% number or better is needed for 2-year average trends to be even with or better on a sequential basis). I am expecting September 2-year average trends in both Europe and APMEA to remain about even with August, which implies about 10% and 3.5% growth, respectively. Based on these assumptions, 3Q09 comparable sales growth will have decelerated on a 1-year basis and 2-year basis in two out MCD’s three geographic segments. I am looking for 1.8% same-store sales growth in the U.S. (vs. +3.5% in 2Q09), +1.7% in APMEA (vs. +4.4% in 2Q09) and +6.9% in Europe (in line with last quarter).
Traffic in the U.S should be helped in the quarter by the increased number of promotions MCD has offered, particularly around McCafe and the Angus burger. The obvious downside to that is the impact on average check and U.S. margins. It will be difficult for the company to sustain its last two quarters of 50 bp YOY U.S. restaurant margin growth with this level of promotional activity though the margin comparisons continue to be easy with YOY restaurant margins down 20 bps in 3Q08 and down 60 bps in 3Q07.
Other things to consider in the quarter that will help to offset top-line weakness include the YOY easing of commodity costs and currency in the second half of the year. Specifically, management guidance stated that in the U.S. its basket of goods should increase 3%-3.5% for the full-year, which implies about a 1% increase in the back half of the year. In Europe, the company’s revised outlook assumes commodity costs increase 3%-3.5% as well, resulting in relatively flat costs in 2H09. On a consolidated basis, food costs as a percent of sales should decrease YOY (even with the increased discounting in the quarter), marking the first time this number has come down in 6 quarters. The magnitude of this YOY favorability will become even greater in the fourth quarter as food costs as a percent of sales in 4Q08 were up 170 bps YOY (vs. up 90 bps in 3Q08).
Relative to MCD’s currency guidance, the company said that based on current rates at that time that the negative impact of currency translation would decrease to about $0.04 in the second half of the year (-$0.06 in 3Q turning into a $0.02 tailwind in 4Q) from the negative $0.17 per share impact in 1H09. Looking at rates now, this expected $0.02 benefit in 4Q09 could move higher.
There are still reasons to love MCD. Proving that MCD is a cash machine, the company recently announced a 10% increase in its quarterly cash dividend and stated that it expects to end the year near the high end of its three-year, $15 billion to $17 billion total cash return target. At first glance, this 10% quarterly increase seemed low to me relative to the 33% increase last year, but on a full-year basis, MCD’s dividend will be up 26% in 2009 versus up 8% in 2008. MCD has enough free cash flow to even trump that $17 billion target through increased share repurchases to help provide the financial engineering to make the numbers.
