By Joseph Morrison
The Golden Arches of McDonald's (NYSE:MCD) compromise one of the most famous and valuable logos in the world. There is no way that Dick and Mac McDonald could have imagined the global magnitude of this firm when they reopened their restaurant in 1948 after changing it over from a bar-b-cue restaurant to the self-service drive-in restaurant, to which we are mostly accustomed. What is most fascinating to me is that while the firm is now a global goliath, the model has not changed much. In 1948, the main attraction of the restaurant was the $0.15 hamburgers and that has been the model throughout the history of the firm and gained further emphasis in 2002 with the launch of the dollar menu. That only strengthened with the 1949 introduction of the famous french fries. Those fries, we all assume, account for the "McDonald's smell" to which we are all accustomed and are perhaps the easiest cross-sold item in marketing history.
McDonald's currently has over 32,000 restaurants worldwide, 80% of which are franchises, which has been the expansion model since the first franchising in 1955 to Ray Kroc when he built the McDonald's franchise in Des Plaines, IL., famously a building with golden arches. McDonald's now serves 69 million customers daily across the world according to CEO Donald Thompson. Given the size and scope of McDonald's as a restaurant, it is a good indicator of the consumer particularly in America. The commentary in the conference call is something that I consider a front-line take on economic conditions.
McDonald's reported earnings on January 23, 2013, for the fourth quarter as well as the 2012 full year. Fourth quarter EPS of $1.38 beat expectations of $1.33 and reported $5.36 EPS for the full year. McDonald's experienced comparable sales growth of 3.1% in the United States, 2.4% in Europe, and 1.4% in Asia, Middle East, and Africa (APMEA) for the full year. Overall, McDonald's experienced a 5% revenue growth for 2012 and 3% net income growth excluding currency translation.
According to the call, McDonald's expanded market share in the U.S. in 2012. McDonald's plans to continue this growth in 2013 in the U.S. by keeping the focus on entrées such as the McRib sandwich as well as new introductions. There is also a big focus on creating value for the consumer with new limited introductions to the Dollar Menu. McDonald's, however, experienced lower margins in 2012 in the U.S. with margins falling to 19.5%. Higher commodities costs as well as labor costs contributed to the lower margins. Additionally, in an effort to continue creating value for their consumers McDonald's limited its price increases to 2% against the 2.5% inflation for the sector. McDonald's forecasts 2.5-3.5% inflation for the sector in 2013.
McDonald's also grew share in Europe despite the economic troubles in the Eurozone according to the call. The strategy in Europe is to focus on premium products in conjunction with the reimaged restaurants to create an experience. Share and revenues grew in this region, but McDonald's also saw margins fall in this region to 19.1%. 3% increases in commodities prices as well as labor pressure are credited for the erosion of the margins in Europe. McDonald's is forecasting a 3-4% commodities pricing increase for 2013.
In APMEA, McDonald's is growing and now serves 1.2 million customers per day. Value and convenience is the main driver for McDonald's in the region. In addition to drive-thru and expanded hours, which we are accustomed to here in the U.S., McDonald's offers delivery in this region to expand the value and convenience image. Management is expecting losses due to the reports of selling expired chicken in China. Management addressed this issue in the call and is committed to maintaining the highest safety standards.
McDonald's looks to reinvest $3.2B in 2013 to open more restaurants and continue to reimage restaurants across the world. Management reaffirmed the target of expanding to 2,000 restaurants in China by the end of 2013. G&A expenses rose 4%, which was less than expected, and management is expecting an increase of 2% in G&A expenses in 2013.
While McDonald's does not offer guidance, management reaffirmed targets of 3-5% sales growth and 6-7% operating income growth. Management did comment that there are signs of strength in the American economy, which has been a theme this earnings season. Management did express concerns with continued weakness in the Eurozone, however. Overall, management does not expect macroeconomic conditions to improve significantly and will focus 2013 on operations efficiency and expanding margins.
I view McDonald's as a mainstay firm with strong fundamentals. I do not see anyone in its space that has the brand equity or marketing power that McDonald's does. In this mature market, there is not much room to expand the market, so I look to the ability to maintain a customer base and the ability take share away from competitors. The diversity of McDonald's menu and the dynamic nature of the firm has kept McDonald's as a leader and will continue to keep McDonald's as a buy in my book. I would hold off on buying at this particular moment, only because McDonald's management is projecting negative revenues in January. I would look for this number to come out in February and be a buyer when the price drops.
Additional disclosure: Business relationship disclosure: The article has been written by Wall Street Trading, a group of junior market analysts. Wall Street Trading is not receiving compensation for it (other than from Seeking Alpha). Wall Street Trading has no business relationship with any company whose stock is mentioned in this article.