McDonald’s Corporation — Q1 2019 Form 10-Q
Reporting period: Quarter ended March 31, 2019. Comparisons are with the quarter ended March 31, 2018 unless noted. Amounts are U.S. dollars.
Business context and performance
McDonald’s operates and franchises restaurants. At quarter-end, it had 37,971 restaurants in 120 countries; 35,278 were franchised. Management’s Velocity Growth Plan emphasizes restaurant modernization (Experience of the Future), digital ordering and delivery. The company reported 5.4% global comparable-sales growth, its 15th consecutive quarter of positive global comps.
Financial results
| Metric | Q1 2019 | Q1 2018 | Change/comment |
|---|---|---|---|
| Total revenue | $4.956bn | $5.139bn | Down 4% reported; up 2% in constant currencies |
| Operating income | $2.094bn | $2.143bn | Down 2% reported; up 3% in constant currencies |
| Operating margin | 42.3% | 41.7% | Up 0.6 percentage points |
| Net income | $1.328bn | $1.375bn | Down 3% reported; up 2% in constant currencies |
| Diluted EPS | $1.72 | $1.72 | Flat reported; up 5% in constant currencies |
| Cash provided by operations | $2.021bn | $1.645bn | Increase primarily reflected working-capital changes |
| Capital expenditures | $515m | $553m | Operating cash flow exceeded capex by about $1.5bn |
Foreign-exchange translation reduced Q1 2019 revenue by $262m, operating income by $108m and diluted EPS by $0.09, primarily due to a weaker euro and other major currencies. Systemwide sales rose 6% in constant currencies; comparable sales increased 4.5% in the U.S. and 6.0% in each international segment. Revenue declined partly because strategic refranchising shifts company-operated sales to lower reported franchise fees.
Financial position, liquidity and capital returns
- Cash and equivalents were $2.289bn at March 31, 2019, versus $866m at December 31, 2018. Cash from financing was $221m, including $2.513bn of long-term financing issuances and $415m of repayments.
- Long-term debt was $32.892bn, up from $31.075bn at year-end, primarily due to higher net debt issuances. Debt fair value was estimated at $34.7bn. Shareholders’ equity remained negative at $6.551bn.
- Following adoption of the new lease standard on January 1, the balance sheet included $12.325bn of lease right-of-use assets and $12.397bn of lease liabilities, including $768m current. Adoption was non-cash; the lease liability includes certain reasonably assured renewal periods.
- The company repurchased 5.4m shares for about $964m and paid $887m in dividends during the quarter; total returns to shareholders were described as $1.9bn. Declared dividends were $1.16 per share, versus $1.01 a year earlier.
Material changes and unusual items
- Franchised revenue increased 4% reported (9% in constant currencies), while company-operated sales fell 12% reported (6% in constant currencies). The restaurant base included 314 fewer company-operated locations and 999 more franchised locations year over year.
- Franchised margin dollars rose 3% reported (7% in constant currencies), while company-operated margin dollars declined 12% reported (7% in constant currencies). U.S. company-operated margin pressure included labor, commodity and modernization-related costs.
- Gains on sales of restaurant businesses were $29m, compared with $97m a year earlier, weighing on reported results. Q1 2019 included $47m of additional tax costs related to Tax Act regulations; Q1 2018 included $52m of Tax Act-related tax costs.
- Other investing activity included a strategic real-estate-entity acquisition; the filing attributes the increase in investing cash outflow mainly to this activity. Separately, the company announced its acquisition of Dynamic Yield to support personalization technology.
- Adoption of lease accounting materially increased reported assets and liabilities. Management said the standard may change the timing and classification of some lease expense as leases are added or modified, but did not expect a material impact in any given year.
Outlook, commentary and risks
For 2019, management expected net restaurant additions to contribute about 1 percentage point to Systemwide sales growth in constant currencies; U.S. and Big Five international commodity baskets to rise about 2%–3%; SG&A to be relatively flat in constant currencies; interest expense to increase about 15%–17%; and the effective tax rate to be 24%–26%. Planned capital expenditures were approximately $2.3bn, with roughly 1,200 restaurant openings and about 750 net additions. The company expected to return about $9bn to shareholders in 2019, completing its approximately $25bn three-year return target. It did not provide specific comparable-sales guidance; management estimated a 1-point change in U.S. or International Operated comparable sales would affect annual diluted EPS by about $0.06–$0.07, assuming no cost-structure change.
Management highlighted execution risk in modernization, digital and delivery initiatives; changing consumer preferences and competition; franchisee performance and investment capacity; labor and commodity costs; foreign exchange; food safety and supply-chain disruption; technology and cybersecurity; regulation, tax matters and litigation; and the ability to sustain brand relevance. The filing reported no subsequent events requiring disclosure, no material change in previously disclosed legal proceedings or market-risk disclosures, and effective disclosure controls as of March 31, 2019.
Important facts for investors to verify
- Whether constant-currency sales and operating-income growth persist and translate into reported earnings as refranchising continues.
- Whether modernization, digital, delivery and the Dynamic Yield acquisition produce returns sufficient to offset their investment and operating costs.
- Debt, interest expense and total lease commitments, including the assumptions embedded in lease renewal periods.
- Drivers and sustainability of operating cash flow, particularly the favorable working-capital contribution in Q1.
- Progress against 2019 capital-spending, restaurant-opening and shareholder-return plans, alongside the effects of foreign exchange, commodities and labor costs.