McDonald's Top Line Suffers in Q4'16, Even As Fiscal Discipline And Share Buyback Help Prop Up Earnings
McDonald's ( MCD ) reported its fourth quarter and full year earnings on 23rd January 2017, beating the consensus for both revenue and earnings growth. However, in line with our expectations, the company's top line continued to suffer, likely due to the refranchising activities being carried out by the burger chain and the overlap in the timing of the launch of the very popular All Day Breakfast in Q4'15. In contrast, the company's strict fiscal discipline and massive share buyback program resulted in earnings rising by almost 10% y-o-y in the quarter.
Keeping with the trend seen for a number of quarters now, McDonald's revenues suffered a decline in the three months ended December. However, the softening was expected primarily due to two reasons. Firstly, due to the impact of refranchising, which resulted in the company-operated sales to be increasingly replaced by franchised revenues in the form of rent and royalty, based on a percentage of sales. Secondly, due to the timing of overlap with the launch of All Day Breakfast in October 2015. Going forward, we are likely to see this trend sustaining, as the company works on its goal to be 95% franchised by 2018. Most of the refranchising will take place in the company's key future growth markets: High Growth (consisting of China and Asia Pacific) and Foundational (Japan, India, and other South-East Asian nations). To this end, McDonald's has entered a strategic partnership with Citic and the Carlyle Group in China and Hong Kong to have re-franchised over 3,500 restaurants by mid 2017, towards its goal of refranchising 4,000 restaurants by the end of 2018.
Furthermore, the downtrend being seen in comps didn't help the revenues. Throughout the year, McDonald's comparable sales growth has been far from encouraging. There is a very evident downtrend in its comps, owing mainly to the weakness in the industry and partially to the lack of traction for the company's main turnaround driver: All Day Breakfast. The fourth quarter saw comparable sales growth down to 2.7% y-o-y. Moreover, in the U.S., the comps went into negative territory, at -1.3% y-o-y. One bright spot was its operations in Japan, which is classified as a market under Foundational Markets & Corporate, which continued to perform well, bringing up the comps of the segment to 11% y-o-y. China, too, had a strong quarter with comparable sales of 7.9% y-o-y, bringing the comps for High Growth Markets to 4.7% y-o-y in Q4'16. In contrast, France and Germany, a part of International Lead Markets, continued to be a drag on the company's operations.
In terms of bottom-line, the company saw a notable increase in earnings, owing to its efforts at controlling costs. Operating expenses were down by an impressive 9% y-o-y in Q4'16, supported by the decline in company operated expenses and lower commodity prices. This arrest in operating costs helped offset the impact of declining revenues by pushing the margins upwards to 32.7% in the quarter. Surprisingly, despite higher operating margins, McDonald's net income was down slightly. This was primarily because of the higher interest expense in the quarter. However, this didn't prevent the company from continuing its share buyback program.
Going forward, the company will be heavily relying on its partnership with Carlyle and Citic group to grow in China, which is expected to become the second largest market for McDonald's. The new enterprise is slated to open over 1,500 restaurants over the next 5 years. The company will continue to face tough comparables as the timings overlap the fantastic performance of All Day Breakfast in 2016. To be sustainable in the long term, McDonald's is working on projecting its food as healthy and nutritional. Further, to cut through the waiting time and manage the through-put, McDonald's plans to introduce table service and self-ordering kiosks across its 14,200 stores in the U.S. The concept has been pilot tested at 500 locations in New York, Florida, and Southern California. McDonald's will also introduce a mobile payments platform to make the ordering process seamless. The move is likely aimed towards the younger, more tech-savvy generations, such as millennials, who form the majority of the U.S. population. The company expects this change to provide a boost to average check size. The company maintained its emphasis on long term sustained growth, rather than short term performance, indicating that the path towards future growth remains somewhat uncertain as of now.
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