McDonald's Earnings Beat Expectations -- 2nd Update

By Julie Jargon Features Dow Jones Newswires

McDonald's Corp.'s bet that low prices will bring in customers is paying off for now.

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The burger giant, which beat analysts' expectations in the second quarter, said its $1 drinks promotion and a new line of burgers helped reverse a sales slump in its U.S. business.

But price promotions can't drive sales over the long term, and the company said it isn't relying on short-term tactics to retain customers. After losing customers to rival fast-food chains in the last few years in an increasingly competitive fast-food market, McDonald's decided it needed to first get customers back in the restaurants.

"It's a market share fight," Chief Executive Steve Easterbrook told investors on Tuesday, explaining that McDonald's has gained back some of the customers it had lost.

McDonald's has been introducing new menu items priced with its core, budget-conscious customers in mind and adding more conveniences like self-order kiosks, food delivery and a mobile order and payment app. It has also been remodeling many of its restaurants. Those moves are all longer-term changes the company said it hopes will keep customers coming back.

"People had quit giving McDonald's a chance," said Trip Miller, managing partner at Gullane Capital Partners, a Memphis-based investment firm that owns shares of McDonald's. "To get people to see the changes you're making, you have to drive them in the door. They may not be getting as fast of an experience as they were a year or two ago but it's a higher quality experience."

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McDonald's speed of service has been declining, Mr. Easterbrook confirmed with analysts. But order accuracy and quality perception scores have improved, he said, adding that he hopes the self-order kiosks and mobile-order and pay app will shave seconds off order times.

The chain reported better-than-expected domestic same-store sales growth in the second quarter, contributing to the strongest global same-store sales and traffic growth in more than five years.

Revenue fell for the quarter, however, as McDonald's sold more of its restaurants to franchisees and is no longer collecting the full amount of revenue from them, the company said.

Investors cheered the results, sending McDonald's shares up 5.2% to $159.74.

McDonald's recently found that most of the consumers it had lost in recent years had defected to rival fast-food chains serving cheaper food rather than the higher-priced fast-casual restaurants it had been trying to emulate with healthier items such as salads and snack wraps.

The company said its renewed focus on the fast-food customer led to its recent decision to begin using fresh, rather than frozen, beef in its quarter-pound burgers. It is currently rolling out a line of semi-customizable burgers topped with different ingredients than the usual tomatoes and lettuce. Those burgers, while more expensive than its Big Macs, are a lot cheaper than the ones sold by "better burger" restaurants such as Five Guys.

Executives said they need to be careful about not raising menu prices too much. Restaurants in the last year have taken a hit as customers found it much cheaper to eat at home than to eat out. The gap between the cost of food-at-home and away widened considerably last year as a number of key commodities prices dropped.

McDonald's finance chief, Kevin Ozan, said he is carefully monitoring key inflation indexes to make sure McDonald's price inflation remains below that of food-at-home.

The company has placed a tight focus lately on operations, with plans to encourage underperforming franchisees to sell their restaurants to better-performing ones, resulting in fewer, better operators. RBC Capital Markets, which expects more than 1,000 McDonald's in the U.S. to change hands, says the move could prove to be a "powerful sales driver."

McDonald's also agreed to put up 55% of the cost of certain restaurant upgrades if franchisees agreed to fund an advertising campaign for a national value menu.

The majority of its U.S. franchisees approved the advertising funding and will be renovating their restaurants to include new dessert counters and self-order kiosks.

McDonald's reported net income of $1.4 billion, or $1.70 per share, up from $1.09 billion, or $1.25 per share a year ago. Analysts were expecting earnings per share of $1.62.

Revenue for the quarter totaled $6.05 billion, down from $6.27 billion last year, but above the $5.96 billion analysts expected. Same-store sales rose 6.6% globally and 3.9% in the U.S., beating expectations of 3.7% and 2.9%, respectively.

Write to Julie Jargon at julie.jargon@wsj.com

(END) Dow Jones Newswires

July 25, 2017 14:46 ET (18:46 GMT)