McDonald's Earnings Beat, Sales Miss As U.S. & China Falter

McDonald’s Corporation (MCD - Analyst Report) posted third quarter 2014 results, wherein its earnings beat the Zacks Consensus Estimate, while revenues missed the same. None of the regions posted positive comps in the third quarter.

Adjusted earnings of $1.52 per share beat the Zacks Consensus Estimate of $1.37 by 11%, possibly due to a significant decline in non-operating expenses. Also, it was flat year over year.

Adjusted earnings exclude the impact of increase in tax reserves, impact of the supplier issue in China and also the impact of temporary store closures in Russia and Ukraine. Including the impact of these items, earnings were $1.09 that declined 28% year over year.

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Revenues of $7.0 billion declined 5% year over year and missed the Zacks Consensus Estimate of $7.2 billion by 3.4%. The significant downside reflects poor performances in all its regions. The Asia/Pacific, Middle East and Africa (APMEA) region declined the most due to supplier issues in China.

Behind the Headlines Numbers

In the quarter, revenues from company-operated restaurants declined 7% to $4.60 billion. Revenues from franchise-operated restaurants of $2.40 billion were more or less flat year over year.

Global comps declined 3% year over year, comparing unfavorably with flat comps in the prior quarter, due to negative guest traffic in all major segments.

As per company’s expectations, comps in the United States decreased 3.3% year over year, worse than a decline of 1.5% in the second quarter of 2014. The sluggish comps reflect negative guest traffic amid ongoing broad-based challenges such as difficult economic conditions, a sluggish job environment and stiff competition.

Operating income in the U.S. declined 10% year over year as initiatives to address the current market situation did not reap benefits.

Comps in Europe fell 1.4% year over year and compared unfavorably with second quarter comps decline of 1%. The dismal comps were in line with company’s expectations. It reflects weak performance in Russia where the company is facing pressure from consumer safety regulators who have reportedly kept more than 100 of McDonald’s restaurants under inspection. Also, they have reportedly shuttered a dozen of its units citing multiple violations of sanitary rules. Also, ongoing weakness in Germany added to the woes. Operating income also declined 2% year over year.

After posting positive comps in the first and second quarters of 2014, comps for the third quarter declined 9.9% year over year in the APMEA region. The results reflect the impact of recent food safety issues in China, which has adversely affected comps in China, Japan and certain other markets.

It was found that Shanghai Husi Food Co – a supplier of McDonald’s -- was reusing meat that had fallen on the factory floor as well as mixing fresh and expired meat. This led to food safety concerns among McDonald’s customers, thereby negatively impacting comps. However, the company indicated that it is undertaking recovery strategies to regain customer confidence.

Operating income declined 55% year over year.

Total operating costs and expenses nudged up 0.2% year over year to $4.91 billion. Operating income fell 14% owing to the impact of the supplier issue in the APMEA region and soft performance in other markets.

Guidance

The company expects to continue to experience the current headwinds in the fourth quarter as well. Particularly, it expects comps to remain negative for the month of October.

Our Take

The U.S. business accounts for 30% of the fast-food giant's overall revenues. The region has not been able to post positive comps since Oct 2013 mainly due to heightened competition and a few wrong decisions that have slowed service.

Moreover, the headwinds in the international market have compounded the woes for the domestic market. Going forward, we remain wary of all these issues taken together along with sluggish economic recovery in some of the company’s primary markets, which would put pressure on its business in the near term.

The company is also making marketing and promotional offerings. However, these initiatives are yet to reap benefits and convert into positive numbers for the region.

McDonald’s currently has a Zacks Rank #4 (Sell). Some better-ranked stocks in the restaurant industry include Bloomin' Brands, Inc. (BLMN - Snapshot Report), Jack in the Box Inc. (JACK - Snapshot Report), and Jamba, Inc. (JMBA - Snapshot Report). All these stocks sport a Zacks Rank #1 (Strong Buy).