McDonald’s Earnings Call Nuggets: Margin Headwinds and Share Repurchase Trends

McDonald’s Corporation (NYSE:MCD) recently reported its fourth quarter earnings and discussed the following topics in its earnings conference call.

Margin Headwinds

Brian Bittner – Oppenheimer & Co.: I have a question about just your guidance for 2013 for the 6% to 7% operating income growth. It clearly assumes that your sales do recover nicely, but what it also assumes I guess is that you can better leverage this sales growth than you have recently and really increase some margins here. It seems as though that could be somewhat of a challenge. There are still margin headwinds and even on kind of low single-digit same-store sales growth it could be tough for the franchising company margins to really improve. So, if you could just give us a little more color on the confidence in that 6% to 7% operating income growth given what seems to be some margin headwinds, how are you going to be able to better leverage sales growth if it does recover?

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Don Thompson – President and CEO: I’ll comment on this first one and Pete may have something to add. What I would tell you Brian is we absolutely believe that our 6% to 7% operating income guidance is the right target for our growth over the long-term. As we’ve said throughout 2012, we firmly believe that what we have to do is appeal to more customers. We’ve got to appeal relative to top line growth. We’ve got to have a variety, a stronger variety and a stronger pipeline that’s executed in the various markets. We believe we definitely have that going into 2013 and feel better about the robustness, if you will, of that food pipeline. We know also that these are – 2013 is still going to be a tough economic environment around the world. We know this in Europe; we know it in APMEA. In the U.S., we are seeing some signs of may be a slight recovery. However, having said that, we also know that we have commodity pressures and some labor pressures. So, by no means do we intend to state that 2013 is going to be an easy year. However, we believe our target, 6% to 7%, are the appropriate targets. We believe our plan to continue to focus on food and the menu, to modernize the customer experience, to continue our reimages, to continue to grow relative to the opportunities in new markets around the world; we believe those things will help us to be effective in continuing to build the business.

Kathy Martin – IR: Keith Siegner, Credit Suisse.

Keith Siegner – Credit Suisse: The question I want to ask is about – December by all means on a two year trade-day adjusted basis was a very strong month, one of the best of the year despite Japan’s weakness. When looking at the January guidance were slight negative, while still very strongly as a slight slowdown, and I know you don’t usually like to get into regional breakdowns, but even at a qualitative basis, if there is anything you could offer, is this, you know is some of that coming from the U.S., is the payroll tax maybe playing some role in this. Any regional kind of qualitative data you could give us on January would be very helpful.

Don Thompson – President and CEO: As you know, Keith based upon last year we had a very strong first quarter. In that first quarter we were – we experience sales that were up 7.3%. We had success across markets. The U.S. was particularly strong. Clearly, Europe was very strong, but as we move into 2013, we also know that we’re comping against those success factors. We really talk about things like weather and the fact that where Chinese New Year shift around, so as long as we continue to talk about the entire first quarter, we know we will see some shifts from a January into a February relative to Chinese New Year, but it won’t affect the overall quarter. So we believe that as we move into, as we talk about our first quarter sales, the first quarter sales will mute out many of the things that were – they shifted around during last year. Having said that, it was – as I mentioned it was a 7.5% or 7.3% comp in the first quarter of last year, and so we know we’re going up against that is going to be fairly tough. In the first quarter of the year, we do see as shift from the Chinese New Year perspective out of January into February. So, we know that that’s going to be a part of that. We believe the plans that we’ve seen are solid plans, but nonetheless, we still face some economic challenges around the world.

Kathy Martin – IR: David Palmer, UBS Securities.

David Palmer – UBS Securities: If I can throw in a little one on China, is the consumer reaction there is that chicken supply issue diminishing or is it still as bad as it has been? My major question though is on reimaging. When you factor in the reimaging, the newbuild for relocation and reimages, what percent of the system is now done and where do you think that percentage will be in a year, what lifts are you seeing and do you think that that outperformance continues into year two after reimage such that we might see a cumulative increasing benefit?

Don Thompson – President and CEO: Why don’t we have Tim Fenton give a perspective relative to the chicken supply issues and then I’ll ask Pete to talk a little bit about reimaging.

Tim Fenton – COO: First of all, safety of our food is always top of mind for our customers and it’s one of our priorities. We have strong procedures in place in McDonald’s China for testing all of our products. We test all batches of all of our raw products that come through our doors. So, very little impact in December as a whole, maybe seeing a little bit more, but it’s really an industry-wide situation or broad-based country-wide chicken industry issue that we’re experiencing in China right now.

Peter J. Bensen – EVP and CFO: David, as far as reimaging, in the U.S. we closed the year at about 35% complete on both interiors and exteriors. Europe was a little over 90% done on the interiors. As you know they started sooner and over 50% on the exteriors and APMEA is about 60% done on the interiors and close to 50% on the exteriors. You saw in our guidance that we’re actually reducing the number of reimages in 2013 relative to 2012. Part of that is because of the substantial progress we’ve made in a lot of these countries, including Canada, which we typically don’t break out separately, as well as a conscious decision in certain markets, China being one to redirect some of the capital toward new store openings. As far as the sales performance, it continues to be strong and within our expectations, and as we get more and more history, especially in the U.S., it’s the data I’m most familiar with, we are actually seeing that second year incremental comp sales stronger than the first. So that benefit continues to grow. I think as the trade area and customers get used to the new environment and the more moderate and relevant surrounding, in addition to some of the more investments we do to improve the efficiency, like dual drive-through, sales just continue to build over time. So, it’s going to continue to be a part of our strategy and we are really happy with the results.

Kathy Martin – IR: Michael Kelter, Goldman Sachs.

Michael Kelter – Goldman Sachs: U.S. restaurant margins have declined for two consecutive years now and the pace of declines has accelerated to about 100 basis points or more each of the last two quarters. My question is, is the recent increased focus on value exacerbating the issue at all? And separately, are there any initiatives that you are looking to put in place for 2013 to help stop the slide?

Don Thompson – President and CEO: Hey Michael, just a couple of things relative to the value piece, because we get asked this question quite often. The first thing I’d say is that, in the U.S. keep in mind we always had the Dollar Menu. What we did towards the fourth quarter of last – in the fourth quarter of last year, was really go back to advertising the Dollar Menu more, because we had shifted our media away over to the Extra Value Menu. So, we took it away from Extra Value, put it back over to Dollar Menu. If you look at it from a percent of sales perspective, the Dollar Menu is still in the 10% to 15% range. Typically, we say 13% to 15%, it’s still in that range. So, it has not gone up by some substantial amount, as a result of us going ahead and advertising the Dollar Menu more so in our media. I will also say that the way that we’re advertising Dollar Menu now is more consistent with how we had done it in the past and we got away from that in the second and the third quarters of 2012. So, that really is the difference relative to the Dollar Menu piece.

Peter J. Bensen – EVP and CFO: One of the things we’re doing Michael to – you asked about enhancing it. One of the thing we’re doing in late December we added the Grilled Onion Cheddar Burger which was another reason to visit the Dollar Menu adding some excitement and some new news as well as putting a product on there that actually is better from the food cost perspective.

Kathy Martin – IR: Mitch Speiser, Buckingham Research.

Share Repurchase Trends

Mitch Speiser – Buckingham Research: You answered a lot of my questions in the prepared comments. Just on the cash flow which there isn’t a lot of data in the press release, the share buyback was a bit lower in the fourth quarter. Your dividend payments I think are now exceeding share repurchase. As we look at 2013, and given the increased CapEx budget, should we expect any change in trend in share repurchase activity?

Peter J. Bensen – EVP and CFO: Mitch, regarding the quarter, typically the fourth quarter is our lowest share repurchase as we tend to have our dividend increase in the quarter and we spend a significant portion of CapEx in the fourth quarter. So you typically see our share repurchase less. As you point out, as the dividend continues to increase that continues to be a greater portion of our free cash flow, but we remain committed to our strategy of returning all free cash flow to shareholders over time.

Kathy Martin – IR: David Tarantino, Robert W. Baird & Co.

David Tarantino – Robert W. Baird & Co.: I wanted to come back to the 6% to 7% long-term operating income guidance. My question centers around 2013. You’re coming off a year in 2012 where you didn’t hit that guidance for the first time in recent memory. So, I wanted to ask what your thoughts are on your ability to hit that in 2013 and specifically, maybe you could talk about the degree of difficulty this year relative to the degree of difficulty last year?

Don Thompson – President and CEO: Let me just reiterate something that I mentioned in the formal comments and that was in 2012 we did meet our long-term system-wide sales growth target of 3% to 5% in constant currencies. So, from a top line perspective we did have growth that was in line with what our expectations were. Also, keep in mind, in 2012 that we had some additional G&A investments that we’ve made, incremental G&A investments that we made around several things. One was the Olympics. Another was an incremental investment in technology. We wanted to really establish (new part) technology system which would help us operationally around the world in a stronger fashion. Then clearly, we also had our Owner/Operators Convention. We had several things that came into play. So, I want to make sure that we also put that in perspective. If you were to net those things out, we would have still came in at about – we would had about a 5% growth in constant currencies. So, first, just a level set that’s very important. The long-term targets that we have established are exactly that. They are the long-term average targets that we believe are viable for our business. So, the 6% to 7% is that long-term target. We also know that one year doesn’t change our strategy. One year will not change our results. We don’t think that there’s been a fundamental enough shift for us to change our targets as we move forward, and we think that the plans that we have around the world are strong enough and viable enough for us to again move toward and achieve those targets.

Kathy Martin – IR: John Glass, Morgan Stanley.

John Glass – Morgan Stanley: First, if I could just ask you to clarify the commentary around January, is this a global, I mean, every region phenomenon is negative or is this specifically driven – you highlighted Chinese New Year and some other issues? Is it really just APMEA and maybe we’ll see other regions as being better or slightly positive? Because in the U.S., you really saw a trend change in December, I don’t – I guess we’re all trying to figure out if that’s an anomaly. That’s just a clarification. And then, the margin question, in the U.S., food inflation is going to be half the rate it was in the last two years, and it sounds like you are going to price about in line with inflation. So, why wouldn’t that be a relatively positive sign that you could maybe just hold margin in ’13? I understand it’s sales dependent to some degree; if sales cooperate, you could hold margin for the first time in a couple of years?

Peter J. Bensen – EVP and CFO: John, it’s Pete. On January, it’s not our practice to get into the regional breakout of that. So, we need to get the month behind us and then we will give you all the texture and commentary when we release in early February. As far as the U.S. margin goes, you hit on it. It’s really a top line gain. So well, yes, we are going to experience some relief in the commodity side. We are still going to have a shrinking eating out market based on the most recent projections, anywhere from 20 to 50 basis points are the forecasts I have seen. So, in that environment, it makes it even more challenging from a pricing perspective to recover all of those input costs. So, once we get past the first quarter which is our toughest comparison, I want to believe that the comparisons and the margin performance will be less pressured than it was in 2012. But until – we really see an expansion in the consumer environment and the eating out market, is – you know the margins will continue to be challenged.

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