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MCD Warns of European VAT Increase in 2011

|Includes: McDonald's Corporation (MCD)

McDonald’s (MCD – $78.00) again delivered stellar results yesterday for Q3 2010.  The continued improvement in comp store sales and profitability over the past few years has been remarkable.  Management should be commended for its relative outperformance. 

But, it’s worth noting that MCD management provided a warning sign for FY 2011 that will impact retailers operating in the Euro-Zone.  The VAT will increase in the UK, Poland, Portugal and potentially others.  While MCD management downplays the potential impact on the company’s results, this may become an issue for others as we look into next year.

Here are some quotes from yesterday’s conference call:

Jim Skinner – McDonald’s Corporation – CEO, Vice Chairman, McDonald’s USA
Looking ahead we know the economic environment remains challenging, with austerity measures continuing to be implemented, in January the VAT will increase in the UK, Poland, and Portugal, and others could follow. Yet we remain confident that our business model will endure.

Pete Bensen – McDonald’s Corporation – CFO
Sure. You know, what we know is as we look at and we dealt with this in our European business over the years, as VAT increases  start to come along, we have to be very smart about how we handle that through the menu board. We know the wrong answer is to immediately increase prices the full amount of that VAT increase. So we look at doing it in smaller pieces. Sometimes we try to get a little bit ahead of the VAT increase, do it in small chunks, but really, if you look across the whole continent as you indicate, the economies are in various forms of recovery.

So we really look at the individual markets. What is the consumer’s appetite to pay a little more? What is going on with inflation? So as you point out, as we look at least preliminarily in to Europe next year, we think commodity costs will be up about 3%. That is not an unreasonable number for us to manage through, and if inflation is a sign that the economies are picking up a little bit, and the consumer will be able to pay a little more, then we certainly ought to be able to handle that through the menu board, but as we sit here today, we are just not exactly sure in which markets and when that will be, but to our business model in total, that type of increase in commodities is not insurmountable.

Jim Skinner – McDonald’s Corporation – CEO, Vice Chairman, McDonald’s USA
And David, our business model, this is Jim, will endure there in the European marketplace, particularly when you look at these VAT increases. They are not robust increases. They are incremental increases, and the population there wouldn’t be able to absorb enormous increases, and so I think as we operate throughout the year, as Pete indicated, we will be able to mitigate the impact of those increases and our business model will be able to perform well in that environment.

Pete Bensen – McDonald’s Corporation – CFO
Historically, as Jim mentioned, these VAT tax increases are probably going to be more incremental than they are substantial, and in the past you have had VAT increases that have tended to be more substantial, so you had to take a little longer period to get those bled into the menu board, if you will. So again, I am not sure there is a historical comparison for us to make, especially considering the economic environment and all else that is going on, but again, I get back to the confidence we have that our ability to manage through this with our business model, and new products, the beverages certainly will help. I don’t know that they will have, at least as of now, as you look in to 2011, they probably won’t be as impactful in Europe as they are in the US, but certainly over time all of the markets have beverages in their plans, and on their plates to take a look at.

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