About three months ago, we reviewed McDonald’s (MCD – Free Value Line Research Report on McDonald’s) in this space and highlighted the impact that inflation could have on the fast food industry giant. The main theme was that the company could be able to pass on the cost increases it was expecting, which were in the 2.0% to 2.5% range domestically and 3.5% to 4.5% in Europe. The range is now higher and tighter, with the company estimating a 4.0% to 4.5% increase in costs across the board.
Clearly, this is a stiff headwind in a business that is mature in most western markets. In fact, the new inflation estimate has about doubled on the domestic front—a material change. Still, we believe the company has the wherewithal to navigate this issue in stride.
McDonald’s has a solid customer base that isn’t likely to shift its loyalties because the price of a Big Mac goes up a little. The company provides a unique mix of value, convenience, and consistency that is hard to match. While management has upped its inflation estimates, the price changes passed on to consumers are still likely to be relatively small compared with their aggregate bill and, more importantly, to other food options.
The company’s value proposition has been a key to its success over time. In fact, the recent recession, highlighted by the gray bar on the Graph, was actually a quite prosperous time for McDonald’s. As the historical section of the Statistical Array clearly displays, the company’s earnings increased nicely at a time when many other companies were struggling. While some of this was due to customers “trading down” from higher-priced restaurants, the restaurant’s ubiquitous Golden Arches are a cultural icon around the world that signify good, reasonably priced food—there is little stigma attached to eating a bit more often at a McDonald’s. Moreover, every restaurant is facing similar food-price increases to McDonald’s, so where are customers going to go?
The confidence in McDonald’s future comes partly from the company’s first-quarter results, which, as the Analyst Comment notes, were better than expected at $1.15 a share. That figure can be seen in the Quarterly Earnings box at the bottom left of the most recent research report, with earnings supported by better-than-anticipated top-line results. The Quarterly Revenue box shows that total for quarter. Although analyst Matthew Spencer didn’t alter his quarterly estimates for the remainder of the year on the earnings front, he did increase his revenue numbers for both the remaining quarters and the full year. This can be seen by comparing the current McDonald’s research report with the previous report.
Indeed, a review of the most recent research report, which is available for free, and the last one, which is available to subscribers to Value Line’s premium product offerings, quickly highlights some of the important changes that were made between reports. Although the most notable are the top- and bottom-line adjustments, it is important to note that Spencer’s estimate for the Net Profit Margin fell slightly from 20.5% to 20.2%. (The Net Profit Margin can be found in the estimates section of the Statistical Array.) This is, clearly, a response to the noted increase in inflationary pressures.
Net Profit Margin is net income before nonrecurring gains and losses as a percentage of sales or revenues. Effectively, it is the percentage of revenues that falls to the bottom line as profits. The trend of this statistic is an important one to watch, as it gives an idea of how well a company is utilizing its resources. For McDonald’s, the Net Profit Margin has trended generally higher over the last 10 years, or so. The current estimate change doesn’t materially alter this and is supported by a legitimate shift in business conditions. So it isn’t terribly concerning.
However, should management continue to up its estimate for inflation, resulting in a continued drop in the Net Profit Margin, investors should revisit the company’s long-term prospects. These quarter-over-quarter changes are an integral part of understanding the progress, or lack thereof, of a company over time. While there are any number of statistics that can be highlighted for comparison, the McDonald’s example is a timely and specific one that shows how changes show up on Value Line research reports.
At the time of this article's writing, the author did not have positions in any of the companies mentioned.