McDonald's (NYSE:MCD) recently closed the books on a mixed fiscal second quarter. Sales growth was impressive in its international markets, and profitability rose. However, customer traffic fell in the key U.S. geography, which led to a slowdown in its global expansion rate.
CEO Steve Easterbrook and his executive team sought to put those results into context for investors in a conference call with Wall Street analysts. Below are a few highlights from that presentation.
CFO Kevin Ozan said,
An important part of our U.S. plan includes delivering a balanced mix of both higher average check and comparable guest count growth. We've seen positive benefits in average check. However, we remain intensely focused on increasing customer visits.
Sales gains ticked down to 2.6% in the U.S. division from 2.9% in the prior quarter. McDonald's estimates that this growth rate translated into modest market share expansion that was aided by customers' trading up to higher-priced items and adding on order items from its value menu. These wins pushed average spending higher to more than offset the decline in customer traffic. Management said international markets performed better by logging gains in both average spending and customer visits.
Benefits of delivery
"Delivery's becoming a meaningful contributor to our sales, and in several of our top markets, delivery now represents as much as 10% of sales in those restaurants offering delivery," reported Easterbrook.
More than 1 billion people live within 10 minutes of a McDonald's restaurant, and that fact means the company has a massive opportunity to target growth in the delivery niche. While many restaurant rivals have struggled with the logistics and profitability around this offering, management sees almost no downside to pursuing this market aggressively. It requires "virtually no additional investment," Easterbrook explained, while boosting guest count. At the same time, delivery orders are about twice the size of standard in-person orders. Those figures help explain why McDonald's has ramped up its delivery network to 13,000 restaurants – up from 7,800 a year ago.
Ozan said, "We've taken significant steps to capitalize on the strengths of our business model...all of which are yielding significant benefits to our operating margin as we continue to progress toward our target of mid-40s. Year-to-date, our operating margin was 42%, up from 37% last year."
McDonald's faced higher food costs that, along with rising wages, pushed expenses up during the quarter. Its aggressive refranchising initiative more than offset that decline, though, and the company also got a boost from a lower tax rate. Altogether, adjusted earnings improved 12% to $1.99 per share, and executives foresee continued modest growth in profitability as the proportion of company-owned locations drifts down toward 5% from about 7% today.
"The U.S. is in the first year of executing an ambitious and holistic three-year [growth] plan. Many of the initiatives in the U.S. have been key drivers of the success in our international markets," added Easterbrook.
Management's core challenge today is to take what's working well in international markets, such as modernized restaurants, robust delivery offerings, and compelling menu items, and apply it to the slowing U.S. segment. McDonald's made progress along those goals by upgrading 1,300 domestic locations during the second quarter. To date, it has modernized one-third of the U.S. store base, and executives plan to keep that aggressive pace going for the next few quarters.
The hope is that the new, more convenient restaurant setups will begin boosting sales with help from menu improvements like its cooked-to-order quarter pounder. Investors will know the strategy is working if customer traffic levels in the U.S. start climbing back up toward the market-thumping levels McDonald's is currently enjoying in places like Canada, the U.K., and France. "We've demonstrated our ability to transfer winning ideas across our markets," Easterbrook said, "and that's another reason for continued confidence in our business."