Investors cheered McDonald's and pushed the stock price higher after the iconic fast-food restaurant reported Q3 results on Oct. 22, beating expectations for quarterly profit. Analysts and McDonald's management alike touted the success of the turnaround strategy the company has been attempting to implement.
The company has been struggling over the past couple of years, dealing with decreasing sales. The increasing popularity of fast-casual dining establishments such as Chipotle Mexican Grill and Shake Shack are often cited as being the culprit behind McDonald's woes. The company has responded by revamping its menu with fresher and higher-quality items, and more recently, it has been heavily advertising the arrival of all-day breakfast. While many are crediting these efforts for the recent quarterly earnings surprise, let me review why I'm not ready to buy in on a McDonald's recovery story yet.
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A review of the earnings numbersHere are the numbers McDonald's reported for the quarter ended Sept. 30. The company showed numbers for the same quarter of 2014 for comparison:
Source: McDonald's third-quarter 2015 results.
I should note that the company reported an increase in revenue and operating income numbers only when excluding currency translation for the quarter, but a decrease when factoring in currency. Although it might be tempting for an investor in McDonald's to ignore foreign issues, doing so would be folly, as the burger joint is very much a multinational organization. There are 36,000 locations in more than 100 countries. Operations in established international markets including Australia, Canada, France, Germany, and the U.K. represented about 40% of the Company's 2014 operating income with high-growth markets including China and Russia accounting for roughly 10%. Currency issues are part of the business and can't be ignored. It is also noteworthy that, according to McDonald's report, the company's revenue is flat and earnings are up only 5% when excluding currency translation for the nine months ended Sept. 30.
My point: Don't be fooled by those numbers in the exclusion column. McDonald's is still suffering from total sales stagnation on a worldwide scale.
About those strong earnings numbers ...At this point, you may be thinking that, despite the lackluster revenue performance, the company delivered strongly on bottom-line earnings per share. Aren't profits all that really count, after all? Let's dig a little deeper into that:
Source: McDonald's third-quarter 2015 results.
There is no denying that net income, or total profit, saw substantial improvement this quarter. McDonald's attributed this change largely to a recovery in sales in China, following last year's food supplier issues in that market.
Then there are the earnings per share, here shown increasing by a whopping 28% compared with last year. Note, though, the 5% reduction in shares outstanding over the past 12 months. McDonald's acknowledged the share-buyback program in the quarterly results statement, as the increase in earnings per share is largely due to this event. When holding shares outstanding constant for the year, dividing net income by 983.8 million shares rather than 934.8 million, we end up having $1.33 in earnings per share, reducing the increase from 28% to 22%.But 22% is still a fantastic increase, right? What I am saying here is that,whilethatextra boost from the share buybacks was nice, 5% a year in buybacks is unsustainable if a company is facing stagnating revenue growth. What is more, shares outstanding and the total market value of the company place a cap on this type of returnto shareholders.Here is a chart from McDonald's website showing the inevitable slowdown in the buyback program:
Another point worth noting, andpossibly amore important onethan the share buybacks issue,is that comparable net income benefited over the previous year's net income in part from an increase in tax reserves in the third quarter of 2014 by $0.41 per share. If we were to exclude that one-time item, we could very well be looking at a year-over-year decrease in earnings per share instead of an increase as reported.
Little evidence of a "recovery"After reviewing the numbers from this last quarter, I see no evidence of a recovery in McDonald's business, at least not one driven by revamped menus and increasing same-store sales (total comparable sales decreased by 3.3% from the same quarter last year). As for the arrival of all-day breakfast, we'll have to wait until next quarter's results to see if it has any meaningful effects on sales. Until then, I believe it's too soon to call the new McDonald's strategy a success.
The article Why I'm Not Buying the McDonald's "Recovery" originally appeared on Fool.com.
Nicholas Rossolillo has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Chipotle Mexican Grill. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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