McDonald's Fights Forex, Cost Woes With Strategic Initiatives

On Aug 29, we issued an updated research report on burger giant, McDonald’s Corp. (NYSE:MCD) .

This leading fast-food chain currently operates over 37,000 restaurants in more than 100 countries.

Though the company has solid long-term growth potential but the risks from near-term headwinds might somewhat restrict its growth momentum.

Sales Efforts for its Key Markets

In order to boost comps in the United States, which represents a major portion of the company’s business, McDonald’s aims to increase focus on growing guest traffic. This will be done by accentuating on operational excellence, product innovation, offering a value menu and rolling out more limited-time offerings.

In fact, the company’s first and second phase of All Day Breakfast along with its national value platform – McPick 2 – have been immensely popular among guests in the United States and may continue aiding top-line growth.

On the digital front, McDonald’s has finally begun testing mobile order-and-pay capabilities on its app in the United States and is set to launch the option in nearly all 14,000 U.S. restaurants and 6,000 others in the UK, Canada, France, Germany, Australia and China by the end of this year.

Adding mobile to its ordering options is expected to enhance speed and convenience for customers. Moreover, given McDonald's large footprint in terms of locations, this is expected to boost sales and enhance the company’s competitive position.

Meanwhile, to provide augmented convenience to customers, McDonald’s is increasingly focusing on expanding the delivery service. Also, it is accelerating Experience of the Future (EOTF) deployment in the United States and building on its success in markets around the world. Through elevating the customer experience at McDonald's, this initiative represents one of the greatest opportunities to build on business momentum, besides growing guest counts.

Additionally, McDonalds is adapting to changing consumer preference, bringing more transparency in its operations and trying to attract more health-conscious eaters by altering its practices and food lineup as well.

These apart, the company is also trying to improve its performance in the lnternational Lead Markets as well as the High-Growth Markets. In fact, it intends to drive comps growth in these markets through introduction of value meals, comprehensive focus around new products and value as well as breakfast platforms, customizing the menu to local customer tastes, reimaging of restaurants, efficient marketing and promotions, improved service, and increased convenience via delivery.

Notably, global comps at McDonald’s have been positive over the last eight consecutive quarters.

Increased Focus on Franchising

Currently, nearly 85% of the company’s restaurants are franchised. Going forward, McDonald’s aims to refranchise 4,000 of its restaurants by the end of 2017 with the long-term goal of becoming 95% franchised. We note that increased focus on refranchising will reduce the company’s capital requirements and facilitate earnings per share (EPS) growth and Return on Equity (ROE) expansion over the long term.

In January 2017, the company entered into a strategic partnership and sold the control of its Chinese business, thus reducing its own share to 20%. In fact, it continues to look out for similar partnerships to streamline its business and focus on the quality of its offerings. These deals are thus likely to have an upside impact on the company’s earnings and margins as McDonald's is expected to gain from trimming its overall cost of operations and preserving its capital.

Concerns

With about 40% of McDonald’s operating income coming from the International Lead Markets and over 10% from the High-Growth Markets, the company’s earnings remain vulnerable to negative currency translation. Given that the dollar is strengthening against various currencies, the company’s results are likely to be affected.

Moreover, apart from rise in minimum wage, additional health care costs related to Obamacare in the United States, raise labor costs for the company. Meanwhile, costs associated with brand positioning in all the key markets and ongoing investments in initiatives would continue to weigh on margins, at least in the near term.

In addition to these headwinds, McDonald’s is grappling with difficulties like decelerating growth in Asia along with weakness in some parts of Europe, where the economic/political conditions are expected to be further challenging post Brexit. A challenging sales environment in the U.S restaurant space is further likely to keep the top line under pressure.

Bottom Line

McDonald’s shares have rallied 23.7% over the last six months, as against the industry’s gain of 7.1%. Furthermore, the company’s earnings surpassed the Zacks Consensus Estimate in each of the last 12 quarters, with the trailing four-quarter average earnings surprise coming in at 7.44%.

Various sales and digital initiatives undertaken by the company to reinforce its position worldwide are anticipated to continue driving growth over the long term. This, in turn, will help fight macroeconomic, cost and currency woes.

Zacks Rank & Stocks to Consider

McDonald’s currently carries a Zacks Rank #3 (Hold). Better-ranked stocks in this sector include Papa John's International, Inc. (NASDAQ:PZZA) , Restaurant Brands International Inc. (NYSE:QSR) and Bravo Brio Restaurant Group, Inc. (NASDAQ:BBRG) holding a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

In the trailing four quarters, Papa John's, Restaurant Brands and Bravo Brio pulled off an average positive earnings surprise of 5.10%, 6.46% and 28.27%, respectively.

Zacks' 10-Minute Stock-Picking Secret

Since 1988, the Zacks system has more than doubled the S&P 500 with an average gain of +25% per year. With compounding, rebalancing, and exclusive of fees, it can turn thousands into millions of dollars.

But here's something even more remarkable: You can master this proven system without going to a single class or seminar. And then you can apply it to your portfolio in as little as 10 minutes a month.

Learn the secret >>