Refranchising Initiatives Weigh on McDonald’s Revenue

Revenue fell almost 3% to $6.42 billion for the ninth straight quarter

m1McDonald’s Corp. (NYSE: MCD), the world’s largest fast food provider, announced its Q3 FY16 financial results on October 21st, 2016.

The Oak Brook, Illinois-based Company operates and franchises McDonald’s restaurants. The Company’s segments include U.S., International Lead Markets, High Growth Markets and Foundational Markets and Corporate. Of the approximately 36,525 restaurants in over 120 countries, roughly 30,080 are franchised and over 6,444 are operated by the Company.

McDonald’s International Lead Markets include Australia, Canada, France, Germany, the U.K., and related markets. Its High Growth Markets include China, Italy, Korea, Poland, Russia, Spain, Switzerland, the Netherlands, and related markets. The Foundational markets span over 80 countries across Asia, Europe, Latin America, the Middle East, and Africa. Read more about McDonald’s financial results below.

Q3 FY16 financial highlights

During Q3 FY16, McDonald’s total revenue fell almost 3% to $6.42 billion (1% in constant currencies) from $6.62 billion in the year-ago period, down for the ninth straight quarter due to the impact of refranchising.

McDonald’s has introduced all-day breakfasts, simplified its sprawling menus, and improved service to turn around its business amid intense competition from m2Burger King Worldwide Inc., the brand owned by Restaurant Brands International Inc. (NYSE: QSR), The Wendy’s Company (NASDAQ: WEN), Subway, Dunkin’ Brands Group Inc. (NASDAQ: DNKN), and nimbler upstart chains. Adding to its woes, McDonald’s is facing intense competition in the burger segment from Shake Shack Inc. (NYSE: SHAK), Sonic Corp. (NASDAQ: SONC), Chik-fil-A Inc., and Whataburger that offer a more appetizing menu. Moreover, its competitors such as Chipotle Mexican Grill Inc. (NYSE: CMG) and Five Guys Burgers and Fries have been fast expanding their operations.

McDonald’s global comp sales rose 3.5%, helped in part by the continued popularity of its all-day breakfast and the introduction of new chicken nuggets, marking the Company’s fifth consecutive quarter of positive comparable sales across all segments as well as improved restaurant profitability. Consolidated operating income increased 5% (7% in constant currencies), which included $128 million of previously announced strategic charges, consisting of restructuring and non-cash impairment charges related to the Company’s global G&A and refranchising initiatives.

During Q3 FY16, the Company’s refranchising efforts and cost cuts helped widen its profit margin. In all, McDonald’s reported net income fell to $1.28 billion, or $1.50 per share, hurt by a restructuring charge of $0.12 and currency headwinds of $0.03, compared with net income of $1.31 billion, or $1.40 per share, a year earlier. Excluding items, the Company earned $1.62 per share, beating estimates of $1.48.

m3While McDonald’s still trails competitors in terms of mobile ordering and finding ways to reach consumers outside its restaurants, its small-scale product tests like using fresh instead of frozen beef at certain Texas locations are expected to garner positive results in the coming quarters.

Segmental highlights

During Q3 FY16, McDonald’s same-restaurant sales in U.S. restaurants rose 1.3%, helped by demand for its all-day breakfast, the “McPick 2 for $2” promotion, and the introduction of Chicken McNuggets without artificial preservatives. U.S. operating income rose 8%, reflecting improved restaurant profitability and higher gains from its refranchising efforts.

Comparable sales for the International Lead segment grew 3.3% during Q3 FY16, reflecting strong sales in the U.K. and positive results in Australia, Canada, and Germany. The segment’s operating income grew 2% (5% in constant currencies) fueled by sales-driven improvements in franchised margin dollars across most markets.

Comparable sales in the High Growth segment grew 1.5% during Q3 FY16, as positive performance in nearly all markets was partially offset by negative comparable sales in China due in part to protests related to events surrounding the South China Sea. The segment’s operating income rose 8% (10% in constant currencies), driven by higher restaurant profitability in China.

Comparable sales in the Foundational Markets rose 10.1% during Q3 FY16, led by strong performance in Japan. Operating income declined as Japan’s contribution to the segment’s profitability was more than offset by the impact of strategic charges associated with the Company’s global G&A and refranchising initiatives.

Other highlights

m4Shifting of corporate headquarters: McDonald’s announced on June 13th, 2016, that it is moving its corporate headquarters from Oak Brook, Illinois, to the West Loop neighborhood of Chicago by 2018. The decision follows the trend of trading suburbs for urban centers, as more companies move into urban centers to attract millennial talent.

Restructuring initiatives: Under CEO Steve Easterbrook, McDonald’s is working to change customer perceptions by switching to cage-free eggs and chicken free of certain antibiotics, as well as removing preservatives from menu items including Chicken McNuggets. McDonald’s has also changed its menu to include fresher ingredients and custom-made meals to bring back young customers who have turned to fast casual restaurants that serve gourmet, customizable burgers.

McDonald’s is in the process of consolidating its restaurants to have fewer franchisees in the U.S. This forms part of McDonald’s massive corporate restructuring initiative announced in May 2015, aimed at reorganizing its struggling business. The restructuring effort is set to save the company $500 million by 2018. As part of this restructuring, only 10% of McDonald’s stores will be company-owned by 2018. Currently, 80% of its restaurants are franchisee-owned. McDonald’s is also selling about 3,500 of its 36,000 restaurants as part of these plans.

Returns to shareholders: During Q3 FY16, McDonald’s returned $3.4 billion to shareholders through share repurchases and dividends. This brings the cumulative return to shareholders to $27.8 billion against targeted returns of about $30 billion for the three-year period ending 2016. In addition, the Company announced a 6% increase in its dividend beginning Q4 FY16.

m5McDonald’s rejigs top brass: McDonald’s announced on September 1st, 2016, that its U.S. president Mike Andres will retire by the end of 2016. Subsequently, the Company has appointed Chris Kempczinski to lead the U.S. business effective January 1st, 2017.

McDonald’s is faced with many exits of its top brass; Karen King, the company’s chief field officer, plans to retire at year-end. Erik Hess, senior vice president of customer experience focused on menu and strategy and insights, is also planning to retire. Two other top McDonald’s executives, David Hoffmann, head of the high-growth markets division, and Chief Administrative Officer Pete Bensen, are leaving the company.

Given this development, McDonald’s announced additional leadership changes; in addition to his current role as President of the International Lead Markets, Doug Goare will take on the role of Chief Restaurant Officer, overseeing a number of business functions managed by Chief Administrative Officer Pete Bensen. Charlie Robeson will take on expanded responsibilities as U.S. chief restaurant officer, overseeing operations of McDonald’s company-owned restaurants, franchising and restaurant modernization.

Lucy Brady has been named Senior Vice President of Corporate Strategy and Business Development. She joined McDonald’s in September 2016 and will take on the role vacated by Kempczinski overseeing strategy development, planning and innovation.

Guidance

McDonald’s expects net restaurant additions to add approximately 1 percentage point to FY16 system-wide sales growth (in constant currencies). The Company also expects capital expenditures for FY16 to be about $2.0 billion, less than half of which are expected to be used to open new restaurants. For FY16, costs for total basket of goods are expected to decrease 4.5% to 5% in the U.S., and remain relatively flat in International Lead segment.

In connection with executing against its refranchising and G&A targets, McDonald’s expects to incur additional strategic charges. By 2018 and beyond, McDonald’s expects to refranchise about 4,000 restaurants with a long-term goal to become 95% franchised. The fast food chain plans to open about 900 restaurants in 2016, including about 400 restaurants in affiliated and developmental-licensee markets.

Stock Performance

m6McDonald’s stock stood at $113.93, gaining 3.04%, at the close on Friday, October 21st, 2016, having vacillated between an intraday high of $114.50 and a low of $112.75 during the session. The stock’s trading volume was at 10,107,609 for the day. The Company’s market cap was at $94.36 billion as of Friday’s close.

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