On Tuesday morning fast food giant McDonald’s (MCD) released its third quarter results. The headline grabber was a rare earnings miss, though beneath the surface the numbers actually looked fairly positive in my view. The market did not respond particularly well: McDonald’s shares change hands for under $198 apiece as I type, down around 6% on Monday’s closing price.
First, let’s get that headline miss out of the way. Earnings per share (“EPS”) for the three month period ended September 30 came in at $2.11. That was around 10¢ lower than the consensus estimate of Wall Street analysts, and barely above the $2.10 per share reported in 3Q18. For the nine-month period ended September 30, the company reported net profit of $5.80 per share, around 1.5% higher than the $5.72 per share earned over the first three quarters of 2018. And there you have it: almost $9b wiped off the company’s market value on the basis of those figures.
In reality, there are actually a few things going on here – some positive, some negative. I’ll start with the former. Firstly, global same-store sales growth looks quite solid. In terms of both the third quarter and first nine months of the year, comparable sales were up 5.9% vis-a-vis their respective 2018 periods. Furthermore, that growth was fairly broad based in terms of the company’s operating geographies. Even the relatively stodgy domestic US market managed comparable sales growth of 4.8%.
Secondly, and not unrelated to the point above, total systemwide sales continue to advance in the right direction. As a reminder, this figure represents the sum of all the dollars spent in the company’s restaurants over any given period. Of all the metrics to monitor this is probably the killer one in terms of company health.
Anyway, global system sales increased by $1.3b to $26b in 3Q19. Call that growth of around 5% versus the 2018 period. Over the first nine months of 2019, systemwide sales increased 4%. Both of those numbers jump to around 7% after stripping out negative foreign currency movements. Those FX moves also took off around 3¢ from the $2.11 EPS figure quoted above.
Third, McDonald’s continues to put in a really strong performance outside the United States. International Operated Markets – which includes mature markets such as France, Germany, Australia, Canada and the United Kingdom – posted systemwide sales growth of 7% on a currency-neutral basis. Segmental comparable sales were up 5.6%. Likewise, in its International Developmental Licensed Markets segment, which includes China, Japan and Latin America, McDonald’s reported quarterly systemwide sales growth of 11% (currency neutral) and comparable sales growth of 8.1%.
The key shareholder takeaway from all those points? The springboard for future profit growth looks solid. I mean, the earnings miss has some one-offs in it that won’t much bother anyone with a long-term outlook. Assuming systemwide sales growth carries on in its current vein, then management’s long-term goal of high single-digit EPS growth looks doable.
As for the negatives, two things spring to mind. First, domestic traffic growth is still negative amid a fiercely competitive environment. In other words, fewer folks are visiting McDonald’s in the US. That trend is currently being more than offset by existing customers simply spending more per visit. That said, there’s only so much you can actually spend in a fast food joint, so that trend continuing isn’t something you really want to rely on going forward. Around 36% of the roughly 38,250 McDonald’s stores worldwide are located in the United States. Domestic traffic growth is therefore definitely something to keep an eye on. On the flip side, once you factor in the the strong international performance I mentioned above, global guest count growth actually came in positive.
The second point I would highlight is the valuation. McDonald’s stock traded somewhere in the $210 per share range before third quarter earnings hit the newswires. Full year EPS should come in around the $8 mark, while the annualized cash dividend stands at $5 per share. Let’s call that a forward price-earnings ratio of 26.25 and a dividend yield of 2.4%. Viewed in isolation, that looks fairly expensive to me – and more so given net debt stands at $58 per share. Shaving 6% off the stock price from that level is a drop in the ocean.
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