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5 Key Themes to Follow When McDonald's Reports Earnings

By Asit Sharma – Updated Oct 18, 2016 at 3:22PM

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The quick-service restaurant giant reports earnings on Friday. Can it still demonstrate momentum on several critical fronts?

Image source: McDonald's Instagram page.

When McDonald's Corporation (MCD 0.13%) reports third-quarter 2016 results on Oct. 21, shareholders will seek out clues that the company's turnaround plan, which began last fall, still has legs. The following five themes may prove useful for those who are interested in cutting through the noise of the report to gauge the burger behemoth's progress year to date.

1. Have we hit peak all-day breakfast?

All-day breakfast, the innovation that rallied McDonald's stock off its hospital gurney last year, is showing signs of fatigue. U.S. comparable sales growth dropped to 1.8% last quarter, although for the year, comps are still up 3.5%. While the novelty of all-day breakfast is wearing off, McDonald's can still derive benefits by tweaking aspects of the program. During the organization's second-quarter conference call in July, CEO Steve Easterbrook discussed the importance of being responsive to customer desires. Easterbrook shared that after working out operational challenges, the company is heeding customer requests to offer McGriddles, muffins, and biscuits all day in all U.S. markets this fall. 

Frankly, all-day breakfast isn't a permanent solution to the company's continuing relevance as a competitive quick-service dining option. Yet it's an important intermediate piece in the company's strategy to evolve into a contemporary, "progressive" burger chain. Look for a discussion on Friday of the impact of all-day breakfast on third-quarter comparative sales. 

2. Value execution in U.S. and Germany

Like all-day breakfast, the company's value offering, McPick 2, plays a key role in the intermediate-term strategy. Menu item pairings under McPick 2 change frequently depending on geographic region, with "McPick 2 for $3" and "McPick 2 for $5" being the most prominent configurations.

McDonald's has benefited from commodity deflation this year, as falling prices for its 10 major grocery commodities in the U.S. are projected to be 3.5%-4.5% cheaper than 2015. This trend, coupled with still robust consumer demand for value items and higher margins versus the discarded dollar menu, illustrates why McDonald's wants to push value items to its adherents for the time being.

In particular, investors should pay attention to management's comments on Q3 McPick 2 success in both the U.S. and in Germany, as these two developed markets are characterized by deal-seeking customers who have so far proved responsive to the McPick2 formula. 

3. Refranchising update

As it moves from an organization that's 80% franchised to one that will be almost totally franchised in the coming years, McDonald's is seeking out new partners, particularly in Asia, to take over the beachheads into new markets it's built over the past few decades. News outlets have reported over the past month that McDonald's has received bids on its businesses in China, Hong Kong, Singapore, and Malaysia. It's possible that we'll get one or more concrete deal announcements on Friday. Any such news is likely to be met positively, as franchise margins have proved to be the highest driver of operating income at McDonald's in recent years.

4. The tail end of a massive shareholder initiative -- what's next?

In July, CFO Kevin Ozan announced that McDonald's was nearing the completion of an enormous three-year, $30 billion program to return cash to shareholders through dividends and share buybacks. I haven't been a fan of this initiative, as it increased the company's debt substantially, resulting in a downgrade by the Standard & Poor's credit-rating agency to just three notches above "junk" status.

The program has also cut average cash balances in half, compromising what used to be one of the most pristine balance sheets in the Fortune 500. About $5.6 billion of the promised return to shareholders remains to be executed in the back half of the year. The company's post-release earnings call won't be too soon for management to discuss capital structure, operational cash flow, and debt repayments as they relate to life after the shareholder program. 

5. Clarity on general and administrative spending plans

In November 2015, as McDonald's shared details of its turnaround plan, management floated an ambitious goal to cut $500 million in costs annually from the general and administrative line item on its income statement, by 2018. So far, there hasn't been much visible progress on this front, although executives recently confirmed the target date and promised to share details of restructuring and cost cutting initiatives in the company's third=quarter update. 

Thus, on Friday, investors should have a fairly good sense of the road map to achieving the half-billion dollars in yearly savings. The narrative will almost certainly touch on head count, as McDonald's has signaled on numerous occasions that it's aware of the need to be more efficient with its operational structure, especially regarding its numerous layers of middle management.

Improving overhead productivity will demonstrate that McDonald's can operate more efficiently, even as it figures out methods to jump-start top-line sales. If the company can illustrate tangible gains on its G&A plan, as well as progress on the accompanying themes mentioned here, long-term holders of this stock should have reason to feel reassured after earnings come out later this week.

Asit Sharma has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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