- McDonald's has delivered impressive third quarter earnings.
- The company recorded good growth in all its geographical segments.
- Is this a head fake by McDonald's or can investors trust the rebound to last?
Shares of the world’s largest fast food chain McDonalds (NYSE:MCD) are currently trading just a shade below their all-time high after surging 7.5% after the company delivered strong Q3 FY 2015 earnings. After many years of global declines in comps, McDonald’s posted solid comps during the last quarter in all its geographical segments. The company also stated that it expects comps to be positive in all its geographical segments during the fourth quarter as well.
Despite the ongoing currency headwinds that have been decimating most companies that have huge international exposure, McDonald’s reported EPS of $1.40 that easily beat consensus of $1.27 (McDonald’s receives about 69% of its revenue from overseas markets with just 31% coming from the U.S.). When you include the impact of FX headwinds, McDonald’s EPS expanded 28% Y/Y, and 44% in constant currency. That strong bottom line growth received a powerful boost from lower costs and expenses as well as copious share buybacks.
McDonald’s was not completely immune to currency headwinds though. The company’s top line contracted 5% Y/Y to $6.62 billion primarily due to currency impacts. Excluding FX headwinds, McDonald’s revenue grew 7% Y/Y with all geographical segments showing positive growth. Despite the revenue contraction, the reported figure still managed to beat consensus estimates of $6.44 billion. Comps in the U.S. grew 0.9%, the first positive comp in eight straight quarters. Overall, global comps grew 4% compared to the 0.7% decline recorded during last year’s comparable quarter.
Is This A Turnaround?
It appears as if McDonald’s turnaround, that chief executive Steve Easterbrook has been pontificating about, is beginning to bear fruit. McDonald’s game-plan has been to focus strongly on product innovation, rolling out more time-limited offerings to keep things exciting, and offering a value menu. McDonald’s has also been working hard to trim its overly complicated menus through a slate of training programs and new operational procedures in a bid to speed up service delivery and improve ordering accuracy. McDonald’s new All-Day Breakfast program that was launched in September is a prime example of how the company is trying to change how it works. McDonald’s is also working to enhance the customer experience by deploying a mobile app.
But not everybody is convinced that McDonald’s latest rebound is the real thing. Its detractors have pointed out, and correctly so, that the company has been benefiting hugely from a restaurant industry which is in the pink of health right now. The hotel industry has done well backed by an improving economy and higher consumer spending power. The discretionary sector in general tends to do well when consumers have more money to spend. A favorable macro backdrop that is characterized by a labor market that has been steadily improving (unemployment is still low), generally stable energy costs thanks to prevailing oil prices, and rising consumer confidence have all been playing into McDonald’s hands. The Restaurant Performance Index (RPI) that tracks the general health of the restaurant industry in the U.S. clocked above 100 last month, marking the 30th consecutive of strong readings. Readings above 100 are considered an indication that the industry is doing well.
Strong Performance In Rest Of The World Is Encouraging
While it’s difficult to deny that all these trends have been instrumental in McDonald’s recovery, it’s equally important to note that they are mostly confined to the U.S. Ironically, McDonald’s 0.9% growth in the U.S. was its weakest. Global comps clocked in at 4%, with China driving a lot of that growth. Another irony is that China has lately been a hotbed of fears of a slowing economy, which is a bad thing for the discretionary sector. McDonald’s high growth markets that include China, grew a blistering 8.9% while growth in international lead markets was up a healthy 4.6%.
I believe that McDonald’s impressive performance in international markets provides the best proof that the rebound is real and not just a head fake. It was widely expected that the company’s turnaround efforts would first beat fruit in the U.S. before the rest of the world followed cue. The fact that the rest of the world seem to appreciate the new-look McDonald’s more than the domestic market is great since that’s where most of the company’s revenue comes from anyway. And the fact that McDonald’s guided for another strong performance during the fourth quarter should give investors confidence that the company’s turnaround efforts are really working.