McDonalds Corporation (MCD) Com Stock USD0.01 (CDI)

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McDonald’s third-quarter revenue was up 2% $6.9bn when ignoring currency movements. However, when looking at comparable sales for the group and its franchisees, takings fell by 1.5%, a bigger decline than expected. Growth of 0.3% in the US was not enough to offset declines elsewhere.

Underlying operating profit grew in line with revenue to $3.9bn, in-line with forecasts.

The quarterly dividend was raised 6% to $1.77 per share.

Full-year guidance for operating margins in the mid-to-high-forties remains intact but guidance for interest expense growth has been nudged up to 11%.

The shares were up 1.5% in early trading.

Our view

The weaker demand seen by McDonald’s in the first half has carried through into the third quarter. Meanwhile, it’s too early to tell if an outbreak of E. coli linked to its Quarter Pounder burgers will impact demand significantly or indeed result in a big legal bill. Either way, customers are demanding better value after absorbing years of price rises, and moves are underway to put value offers at the top of the menu.

The Group’s scale and efficiency, combined with easing cost pressures, leave it well-placed to deliver these initiatives, but some execution risk remains.

The largely franchised model is an efficient operation, with McDonald's off the hook for many of the typical restaurant running costs. Cash conversion in excess of 90% means the vast majority of profits feed into cash for the business to either spend or return to shareholders.

McDonald's strong cash flows give it headroom to help cope with bumps in the road and continue its expansion plans, with 1,600 net restaurant openings expected this year. The bias in openings towards franchised operations should help margins once the stores are running at full pelt. It's also been spending on revitalising stores, whilst continuing to improve the digital presence.

Full-year operating margin guidance in the mid-to-high 40% range remains intact. If inflation continues to moderate, we think there is potential to build this out a little more in future periods.

McDonald's is also lugging around a hefty debt pile. Interest costs grew 13% in 2023 as a result of these higher debt balances and interest rates. The group enjoys strong cash generation but given the increased cost of debt, we think paying some of this down should be a priority.

We think McDonald’s brand strength remains key to navigating the softer outlook for demand. The E.coli scare has the potential to do some damage on that front, but over the long term, we expect the brand will shrug that off. With the valuation above the long-term average however, sentiment is likely to remain sensitive to further developments in this unfolding story as well as any blips in demand.

Environmental, Social & Governance Risks

Consumer services companies are medium-risk in terms of ESG, and very few companies are excelling at managing them. That leaves plenty of opportunity for forward-thinking firms. The primary risk-driver is product governance. The impact of their products on society, labour relations and environmental concerns are also key risks to monitor.

McDonald’s overall management of material ESG issues is average according to Sustainalytics. But there are some product governance concerns including controversy over an outbreak of E.coli. There are also question marks over labour relations where it has been the subject of multiple lawsuits and in major controversies. The company discloses sustainability information in its Purpose & Impact Progress Summary; however, there is no evidence that it follows ESG reporting standards.

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