We remain Neutral on McDonald’s Corp. (MCD) over the long term. Our reiteration is based on the company’s growing same-restaurant sales, ability to attract healthy traffic in spite of menu price increases and restaurant reimaging program, partially offset by steeply rising commodity costs, the recent E. coli epidemic in Germany and tough competition.
Increasing Same-restaurant Sales: We are impressed with the same-restaurant sales of McDonald’s that has been on the rise for last several quarters. Product innovation, along with value menu offerings and a variety of items like the new Fruit & Maple Oatmeal, McCafe premium beverages, Chicken McNuggets and Chipotle BBQ Bacon Angus burger perked up the U.S. comps. While McDonald’s new frozen Strawberry Lemonade is performing well and was the key contributor to May comparable sales, management expects another flavor –– Mango Pineapple Smoothie –– to drive comparable sales in June.
Further Expansion in Beverage Line-up: McDonald’s remains fairly optimistic on the beverage business. The company has noted that coffee accounted for only 2% of sales two years ago and now represents over 6% of sales with room for incremental growth. Beverages are also getting a lot of attention outside the United States. The company had more than 145 McCafes in China and more than 1,350 in Europe at the end of first quarter 2011.
Pricing Actions to Combat Rising Costs: McDonald’s has been resorting to menu pricing globally as counter measures against cost inflation. In March, the company increased its prices by 1% in the U.S., and will likely consider further rises during the rest of 2011.
Reimaging Program to Add to Growth: We are also encouraged by the company’s reimaging program, which is expected to spur sales. Management indicated that it sees a 6–7% sales lift from revamped U.S. units.
Rising Input Costs: The global commodity markets have experienced significant increases since January. McDonald’s expects commodity costs to increase 4.0% to 4.5% year over year in 2011 in the U.S, with greater pressure in the second and third quarters.
E. coli Outbreak in Germany: We believe the recent E. coli outbreak in Germany will continue to hurt the restaurant sales in that country. Last month, McDonald’s witnessed slower growth in European comparable sales due to weak spending in Germany.
Competition: Although McDonald’s is planning to boost its investment in China by 40% this year as compared to 25% last year, Yum! Brands Inc. (YUM), one of its major competitors, has a much stronger presence in that country. In addition, the acceleration of restaurant openings in China is contributing less to the margin as they are at their initial stages of operation.
Agreement –– Estimate Revisions
Over the last 7 days, there was no movement in the earnings estimates for McDonald’s. The current Zacks Consensus Estimate is $1.28 for the second quarter, reflecting a year-over-year growth of 13.0%.
Based on the above fundamentals, we expect the company to perform in line with the market. The quantitative Zacks #3 Rank (short-term Neutral rating) for the company indicates no clear directional pressure on the stock over the near term.
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