McDonald’s Corporation — Q3 2016 Form 10-Q
Business context and period. Unaudited results cover the quarter and nine months ended September 30, 2016, compared with the corresponding 2015 periods. McDonald’s franchised and operated 36,615 restaurants in 120 countries; 30,559 were franchised or licensed and 6,056 were company-operated. Management was pursuing refranchising, restructuring and a longer-term goal of becoming 95% franchised.
Financial performance
- Third quarter revenue: $6.424 billion, down 3% reported and 1% in constant currencies. Company-operated sales fell 7%, while franchised revenue rose 5%.
- Third quarter earnings: Operating income was $2.137 billion, up 5% (7% constant currency); net income was $1.275 billion, down 3%; diluted EPS was $1.50, up 7%. EPS benefited from fewer shares outstanding following repurchases. The effective tax rate was 33.0% versus 30.3%.
- Nine-month results: Revenue was $18.593 billion, down 3% reported but flat in constant currencies. Operating income was $5.776 billion, up 10% (12% constant currency); net income was $3.493 billion, up 5%; diluted EPS was $4.01, up 15%. The nine-month effective tax rate was 31.9% versus 31.4%.
- Sales and margins: Global comparable sales increased 3.5% in Q3 and 4.2% for nine months. Company-operated restaurant margin was 18.4% in Q3 versus 15.8% and 17.0% for nine months versus 15.2%. Nine-month consolidated operating margin was 31.1% versus 27.6%.
- Cash flow: Nine-month operating cash flow was $5.245 billion; capital expenditures were $1.150 billion, leaving operating cash flow above capex by approximately $4.1 billion. Cash ended September at $2.267 billion, down from $7.686 billion at year-end 2015.
- Debt and liquidity: Long-term debt was $26.007 billion, up from $24.122 billion at December 31, 2015. Total debt obligations were $26.0 billion; estimated fair value was $28.8 billion. Current assets were $4.302 billion and current liabilities $4.477 billion. Shareholders’ equity was negative $1.624 billion, with treasury stock of $50.761 billion.
- Shareholder returns: The company repurchased $9.662 billion of stock and paid $2.285 billion in dividends during the first nine months. It reported approximately $28 billion returned toward a roughly $30 billion three-year target through 2016. The board declared a fourth-quarter dividend of $0.94 per share.
Material changes and management commentary
Refranchising reduced reported revenue as company-operated sales shifted to lower, rent- and royalty-based franchised revenue, while franchised revenues and margins increased. Management attributed operating improvement to stronger restaurant performance and higher gains on restaurant sales. Results included $128 million of Q3 and $357 million of nine-month restructuring and non-cash impairment charges; 2015 nine-month results included $240 million of strategic charges. Excluding current- and prior-year charges, diluted EPS increased 16% for Q3 and 17% for nine months.
Comparable sales were positive in each segment. U.S. Q3 comparable sales rose 1.3%, International Lead Markets 3.3%, High Growth Markets 1.5%, and Foundational Markets & Corporate 10.1%. China weighed on High Growth Markets in Q3, partly due to temporary protests related to South China Sea events and comparison with strong prior-year results. Management said it was transitioning from business revitalization toward strengthening the business for sustainable growth.
Outlook, risks and unusual items
- Management expected 2016 net restaurant additions to contribute about 1 percentage point to systemwide sales growth in constant currencies; planned approximately $2.0 billion of 2016 capital expenditures, about 900 openings and approximately 400 net additions.
- For 2016, U.S. commodity basket costs were expected to decline 4.5%–5.0%, while International Lead Markets costs were expected to be relatively flat. SG&A was expected to be relatively flat in constant currencies.
- Full-year 2016 interest expense was expected to rise 40%–45% versus 2015, reflecting higher average debt. The expected effective tax rate was 31%–33%. No specific EPS guidance was provided.
- Longer-term plans included refranchising about 4,000 restaurants through 2018, achieving about $500 million in annual net G&A savings (vast majority by end-2017), and returning about $30 billion to shareholders for the three years ending 2016. Further strategic charges may occur.
- Management identified currency exposure as significant: a simultaneous 10% move in the Euro, British Pound, Australian Dollar and Canadian Dollar could change annual diluted EPS by up to $0.25. Other risks include competition, consumer preference shifts, commodity and labor costs, franchisee performance, food safety, regulation, litigation, technology/security, and execution of refranchising and cost initiatives.
- No subsequent events requiring recognition or disclosure were reported, and the filing reported no material changes to previously disclosed legal proceedings. Adoption of lease accounting was expected to materially affect the balance sheet; its income-statement impact was still under evaluation.
Important facts for investors to verify
- Whether comparable-sales momentum persists and offsets the reported-revenue effect of refranchising.
- Progress and costs against refranchising, G&A savings, net restaurant additions and shareholder-return targets.
- Debt growth, interest expense, cash levels and the sustainability of repurchases and dividends.
- Underlying earnings after restructuring and impairment charges, and the impact of foreign exchange and tax-rate variation.
- Execution risks in China and other challenged markets, and the eventual balance-sheet effect of the new lease-accounting standard.