Inflection Point Confirmed : McDonald's Q3 Earnings Review

  • EPS comes in at $1.4 - a whopping $0.12 more than estimates. Revenues drop due to currency headwinds.
  • US comparable sales growth of 0.9% is the first growth in last 7 quarters.
  • China rebounds strongly after ugly meat scandal last year. It has huge potential for McDonald's

McDonalds (NYSE:MCD) stock closed at $112.59 on Friday, up almost 10% since it announced strong earnings on 21st October, before the bell. Revenues fell slightly due to the strength of the dollar but earnings per share (EPS) came in at a whopping $1.4 a share which beat analysts expectations by a margin of $0.12.

The earnings beat illustrated just how important the US market is to this company. Many analysts including myself didn't think the US would return to growth until 2016, so reporting same-restaurant sales growth of 0.9% (analysts were predicting a 0.2% decline) would have hurt many bears as the share price rallied accordingly. McDonald's generates around 40% of its revenue and 50% of operating income from the US market, so growth here was always going to launch the share price meaningfully.

However, growth came across the board for the company with established international markets (Germany, UK, Australia, etc.) growing 4.6% and high growth markets (China, Poland, Spain, etc.) growing almost 9%. Total growth for same store sales averaged out to be over 4% which was more than double of analysts' forecast. This company now has serious momentum behind it, especially in the US, considering the "All Day Breakfast" which has been already highlighted as a success by officials (but was not reflected in third quarter earnings) was launched very late in the quarter. Let's discuss why there should be more growth to come.

All Day Breakfast

Firstly the fundamentals still look very sound compared to the quarter of 12 months prior, especially when you factor in the strength of the dollar ( currency translation in table below). The only glitch is the company's operating income, which is down as a result of the company raising its minimum wage to $10/hour in about 1500 McDonald restaurants.

mcd9

Now with the US market having a full 3 months of "All Day Breakfast" ahead of it, you would feel that Q4 will deliver much stronger same stores sales growth than the 0.9% reported in Q3. The US is critical because it is practically half the company and if 2% growth could be reported in the next quarter in same store sales, that would be an extra $52 million of sales within this market. Furthermore in terms of rewarding shareholders, the company is still on track to return approximately $8 to $9 billion this year (if not surpass it if we get another bumper quarter) through share buybacks and dividends as the company returned $3.1 billion which brings the year to date total to $7.1 billion.

China: A Huge Potential Market

Secondly China could seriously give McDonald's momentum as it is a huge market and could provide meaningful growth going forward. McDonald's suffered a lot in China last year due to the meat scandal (where expired meat was being sold to fast food joints) and the company lost a lot of customers as a result. This country has been put in the "strong growth" division and with good reason. The country has only 2000+ restaurants compared to 14,000+in the US but China has 4 times+ the population!. As an investor it is forward looking commentary we look at most and with China now reporting strong growth, there seems ample room for revenue growth for the company here. Franchises are also on the up in China which should help margins over time due to less money being tied up by the company.

Once McDonald's gets over its US slump for good, I believe this company will continue to grow revenues and operating income in single digits (4 to 6%) from here. Why? Its system. It will continue to open restaurants in new markets and now that it has bettered its reputation recently (through declaring that it will use chicken without antibiotics and offer variations to its cheap greasy food), one would think that if the world economy picks up from here, this company can now compete with the likes of Chipotle Mexican Grill (NYSE:CMG) and fast casual segment. On the contrary if the world goes into recession, this company will gain market share as few will be able to compete with it on price, value and scale.

Bottomline

To sum up, you are going to see bears coming out again stating that McDonald's still has some serious problems and sustained growth will not happen going forward. Don't listen to them. Just look at the long term fundamentals of this company and monitor its share price performance both from a capital gains side and an income side and you will see that shareholders have always been rewarded handsomely in this company. The company already has an impressive dividend track record in terms of annual increases and growth rates. Expect its next dividend increase which is due in December to be sizable so waiting for a pullback here fro income investors may be risky as it may never come.

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