McDonald's (MCD -0.25%) offset the impact of rampant inflation and rising costs by hiking prices, but president and CEO Chris Kempczinski hints there may be a storm brewing on the horizon.
Although consumers seemed willing to pay up in the quarter as comparable-store sales in the U.S. rose 3.5%, beating analyst expectations of a 3% increase -- and rose much higher elsewhere in the world -- Kempczinski said consumers are also beginning to trade down on the menu for less expensive items.
In "certain parts of the business and in certain geographies, there is a little bit of a trade-down that we're seeing that we're just keeping an eye on," he told analysts.
Even for a value chain like McDonald's, the worst inflation in over 40 years can eventually impose a significant toll on its business.
Strong results in a worsening economy
Revenue in the first quarter jumped 11% from last year (14% excluding currency exchange fluctuations) to $5.67 billion, reflecting the increase in comps, which soared 11.8% globally. Much of the gains, though, were driven by price hikes, which averaged 8% for the period, a significant jump in normal times, but actually somewhat low when considering the Consumer Price Index rose 8.5% in March. That was the fastest one-month increase since December 1981 and higher even than what economists were predicting.
McDonald's says it's not surprising that these conditions are impacting its lower-income customers more than middle- and high-income ones, which is why it's watching the situation. But Kempczinski also points out that is why it's important for the fast-food chain to be a value menu leader.
When McDonald's has moved away from value as it has in the past, its business tended to run off the rails. "We need to make sure that we continue to have value be an important part of our proposition," Kempczinski said.
The worsening economic situation, though, is why McDonald's is seeing fewer transactions per order and smaller order sizes. It hasn't been a major factor yet in disrupting growth, so the restaurant stock was able to beat Wall Street's estimates. However, with no end in sight to soaring inflation and expectations that conditions will worsen, that may not be the case in future quarters.
Yet, part of what's helping McDonald's blunt the dicey economic landscape has been the continuing success of its customer loyalty program, MyMcDonald's Rewards, which it relaunched last year and saw grow to 26 million members.
Digital sales -- which include mobile orders, in-store kiosk orders, and delivery -- now accounts for 30% of total sales, a 60% gain year over year. While McDonald's has always had a fairly loyal customer base, its digital initiatives are helping to drive more repeat business, and it now boasts of having the largest fast-food delivery program in the world.
Delivery is even more important internationally than it is here because there is much lower drive-thru penetration than in domestic markets. In fact, the company has signed a new agreement with Just Eat Takeaway.com, Europe's biggest third-party delivery service, to go with its global arrangements with Uber Eats and DoorDash.
Making its food more accessible to more people in more ways has paid off for the fast-food chain.
Storm clouds brewing
The first quarter was a strong one for McDonald's, even with the costs that the war in Ukraine is imposing on its business. Russia accounts for about 9% of total revenue, and the restaurant was slow to sever its ties with the country. It now estimates it will cost about $55 million a month as it continues to pay its staff there during the operations suspension.
Despite the hit to sales it will suffer, McDonald's looks like it should continue growing for the rest of the year elsewhere in the world. However, with the prospects of stagflation at home, war in eastern Europe, and continuing COVID-19 lockdowns in China, investors should prepare for darker clouds potentially dimming the Golden Arches in the quarters to come.