We have to tip our hats to McDonald's Corporation (MCD) for its performance since it hit its "rock-bottom" in 2002. We remembered how McDonald's was a high-performing fast-food restaurant chain up until the 1990s but floundered under the management of Michael Quinlan and Jack Greenberg. We remembered how it regained its performance leadership and momentum in the 10 years since it wrote off over $850M in asset write-downs and operating expense charges.
Jim Cantalupo replaced Jack Greenberg at the beginning of 2003 and had overseen double digit sales growth for McDonalds in 2003 and for Q1 2004 until his sudden death from a heart-attack in April 2004. Charlie Bell, the man tapped to replace Cantalupo was diagnosed with colon cancer not long after becoming CEO. He eventually resigned in November 2004 as the cancer became incurable and died not long after.
Jim Skinner, the President of McDonald's Restaurant Group operations, was chosen to succeed Bell. Skinner helped stabilize the executive ranks and continue the turnaround progress that began under Cantalupo and Bell. Skinner served as CEO from November 22nd, 2004 to June 30th, 2012 and Don Thompson succeeded him upon his retirement. During Skinner's tenure as McDonald's CEO, EPS had increased from $1.79 in 2004 to $5.27 in 2011.
McDonald's was not the only blue-chip company to see negative headwinds to financial performance from recent global macroeconomic headwinds, most notably in the form of negative translation effect from the strong U.S. dollar versus other global currencies. McDonald's saw a small increase in its Q2 2012 revenues versus Q2 2011 levels as increased revenues from its franchisees offset a slight decline in revenue from its company owned stores. Negative currency translation costs were $333M in the quarter and represented over 4.8% of its revenues. European revenue declined by 3% at its company-owned restaurants and 4% at its franchise-operated restaurants. After excluding the impact of the weak European currencies (most notably the euro), constant currency revenues increased by 7% for each channel. The United States saw 2% growth at its company-owned restaurants and 5% at its franchise-operated restaurants. MCD's Asia, Pacific, Middle East and Africa segment saw its company- owned sales increase by 2% reported (4% constant currency) and its franchise-operated sales increase by 3% reported (8% constant currency). The biggest concern was that so far in the third quarter of 2012, MCD's comparable store sales dipped into negative territory for the month of July, versus a 3.6% in the Q2 2012 period. The biggest concern was not that all regions saw negative comps but rather that the biggest decline was in the APMEA region (a region we expect to have higher growth due to a lower level of relative penetration).
The negative headwinds that McDonald's saw from the currency translation effect (particularly in the Eurozone) helped exacerbate a tepid and pedestrian operating performance. On a constant currency basis that excludes the impact of currency translations into US dollars, the company only grew its EPS by 3% in Q2 2012 versus Q2 2011 levels. Negative currency translation headwinds reduced revenues by nearly 5% and achieved the same negative effect on operating income. Even before the economic slowdown and negative currency headwinds, we were disappointed that the company only grew its operating income by 3%. We had become accustomed to seeing higher operating income growth and we guess Skinner picked a good time to retire, that way he can leave before the growth momentum truly dissipates. Even with the efforts by Burger King Worldwide to restructure and improve its operations, McDonald's still outclasses its competition in terms of operating margins.
On a cash management basis, McDonald's is still the Golden Arches with regards to other burger chains. McDonald's generated nearly $1.5B in free cash flows during Q2 2012 after generated $1.6B in Q1 2012. After McDonald's made over $685M in net capital investment expenditures during the most recent quarter, it borrowed $900M in order to pay nearly $710M in common stock dividends and nearly $690M in net share repurchases. We can see that this outpaces other burger chains like Wendy's (WEN), which only paid $30M in YTD dividends and Burger King Worldwide (BKW), which is focusing on deleveraging its balance sheet. At least Burger King can say that while McDonald's is levering up its balance sheet by $900M during the quarter, Burger King is deleveraging its balance sheet by $85M. Then again, McDonald's can afford to lever up its balance sheet since its weighted average interest cost is about 4% while Burger King's is 7.15%.
In conclusion, we remain impressed with McDonald's. We are not fool-hardy to bet against the Golden Arches, especially due to its worldwide leadership in the quick-service restaurant industry. McDonald's is also the dividend champion of the fast food and quick-service industry as well as the share buyback champion. We also like the fact that it is at 6% above its 52-week lows.
We most certainly believe that Burger King Worldwide can even hope to compete at the same level as McDonald's due to BKW's years of being subject to the financial engineering whims of the private equity sector. However, based on the global macroeconomic headwinds that the company is facing, the negative effects from currency impacting its balance and Justice Holding's recent efforts and initial progress in restructuring Burger King, we would say to McDonald's stakeholders "Don't look back, Burger King is gaining on you."
We don't believe that Burger King has shaken its also-ran status to McDonald's anytime soon. McDonald's is undoubtedly the best performing burger chain in the world. However, we believe that the new actions taken by Justice Holdings and 3G are setting up Burger King to be the "pest" burger chain worldwide.
Additional disclosure: Saibus Research has not received compensation directly or indirectly for expressing the recommendation in this report. Under no circumstances must this report be considered an offer to buy, sell, subscribe for or trade securities or other instruments.