McDonald’s Corporation (NYSE:MCD) Q2 2023 Earnings Call Transcript

McDonald’s Corporation (NYSE:MCD) Q2 2023 Earnings Call Transcript July 27, 2023

McDonald’s Corporation beats earnings expectations. Reported EPS is $2.55, expectations were $2.52.

Operator: Hello, and welcome to McDonald’s Second Quarter 2023 Investor Conference Call. At the request of McDonald’s Corporation, this conference is being recorded. Following today’s presentation, there will be a question-and-answer session for investors [Operator Instructions]. I would now like to turn the conference over to Mr. Mike Cieplak, Investor Relations Officer for McDonald’s Corporation. Mr. Cieplak, you may begin.

Mike Cieplak: Good morning, everyone, and thank you for joining us. With me on the call today are President and Chief Executive Officer, Chris Kempczinski; and Chief Financial Officer, Ian Borden. As a reminder, the forward-looking statements in our earnings release and 8-K filing also apply to our comments on the call today. Both of those documents are available on our Website as are reconciliations of any non-GAAP financial measures mentioned on today’s call along with their corresponding GAAP measures. Following prepared remarks this morning, we will take your questions. Please limit yourself to one question and then reenter the queue for any additional questions. Today’s conference call is being webcast and is also being recorded for replay via our Web site. And now I’ll turn it over to Chris.

Chris Kempczinski: Thanks, Mike, and good morning. Last quarter, I talked about consistency, consistency in our numbers, consistency in the drivers of our business and consistency in the excitement across the system about the opportunities ahead. This quarter, the theme is — well, if I’m being honest, the theme was Grimace. I mean, Grimace has been everywhere the past few months, all over the news and more than 3 billion views on TikTok. Not bad for a 52nd birthday. This viral phenomenon is yet another proof point of the power of marketing at McDonald’s today. Aside from Grimace, what really stood out about this past quarter was our continued consistency. In Q2, we delivered yet another quarter of strong performance, achieving global comparable sales of 11.7% with double digit comparable sales across each of our segments.

We’re operating from a position of strength and continuing to gain share in most of our major markets despite headwinds and a challenging macro environment. The reason for this continued consistency is simple, our Accelerating the Arches playbook is working to help create a better customer experience. Renewed focus on the fundamentals, in part fueled by the reintroduction of the PACE program, has led to operational improvements and continued increases in customer satisfaction across most of our major markets. To further strengthen our foundation of running great restaurants, we recently created a Chief Restaurant Officer role in markets to keep our market teams focused on driving our strategic plan, execution and performance. Market CROs will also help ensure that innovative ideas generated in local restaurants can be leveraged in markets across the globe.

Our success is fueling even greater ambitions. We’re continuing to double down on our existing growth pillars while evolving our strategy through accelerating the organization to stay front footed with an eye towards the future. As we’ve previously shared, accelerating the organization is an initiative to reimagine how we work to bring the full breadth of McDonald’s skills and experiences together to come up with the best solutions that can be scaled. We’re bringing this to life through One McDonald’s Way, horizontal ways of working and digitizing the organization. While we’re just beginning to change our ways of working, we’re already seeing early benefits. I’ve often said that the next great solution will come from our markets and in our restaurants.

As I recently visited markets like China, Italy and Germany, I continue to be inspired by the entrepreneurial spirit of our system and how market teams are embracing these principles even more consistently. Visiting China truly brought to life the power of a highly digitized economy and our potential for global growth moving forward. With about 90% of our business currently coming through digital channels in that market, it was remarkable to see how the market has forged digital relationships with customers. China is also making tremendous progress in running the restaurants more efficiently, all with the use of data and technology. This will provide great learnings for the rest of our system. Our Canadian team is implementing a rigorous initiative review process to relentlessly prioritize work to actively stop projects that are less important and focus on solving the most meaningful problems for our customers.

Using a new framework, the team has already cut their number of key business projects in half. We intend to learn from and scale this process to other markets as well. Additionally, our UK and Ireland team recently traveled to Germany to learn best practices from the market’s best burger rollout. This is a prime example of the agile scaling of solutions and horizontal ways of working. And finally, last November, we launched our largest globally unified marketing campaign ever, Wanna Go to McDonald’s, to celebrate the FIFA Men’s World Cup. We’re thrilled to extend this award winning brand platform with the FIFA Women’s World Cup and write a new chapter in the story to meet this iconic cultural moment. This campaign will be brought to life in 28 markets through fully integrated social, digital streaming and content strategies that tap into local fan excitement.

These are just a few examples of how a One McDonald’s Way approach to common challenges will drive greater connectivity and efficiency worldwide. Key to enabling the company’s scale solutions with speed and agility is the work of our new Global Business Services business unit, or GBS. GBS will unlock further efficiencies and capabilities of our people and resources. We will do this by developing digital tools for the organization, making data and insights more accessible across the system and growing our future talent pipeline. We’ll continue to keep you updated on how our ongoing investment in this area will benefit the enterprise in the years to come. In addition to our accelerating the organization efforts, we’re also focused on evolving our approach to capturing incremental customer visits.

Central to that is restaurant development, also known as our fourth D. Our strong performance and strength of our brand has earned us the right to begin accelerating the pace of restaurant openings in our major markets over the next several years. While our primary focus is on opening traditional units, we are always testing and learning new ways to meet the needs of our customers. One example is the takeaway only restaurant in Fort Worth, Texas that opened in 2022. The restaurant site is considerably smaller than a traditional restaurant and as the way customers order and receive their food has changed dramatically over the past few years is geared toward customers based on their need state wherever they are. Another recent example of innovation I was able to see firsthand during my visit to China is the use of food lockers at busy locations with high in-store traffic.

Upon arrival, delivery couriers can quickly unlock the designated locker and grab the customer’s order without even entering the restaurant, removing friction for both the kitchen and the courier. And our new business ventures team is in the process of developing a new concept we will call [CosMc’s], which we will test in a small handful of sites in a limited geography beginning early next year. [CosMc’s] is a small format concept with all the DNA of McDonald’s but its own unique personality. We look forward to providing you with more information about our development plans and new format innovations at our Investor Day at the end of the year. Finally, before I hand it to Ian, I want to recognize our teams and business partners in France who have handled the unrest in the market with remarkable strength and grace.

It has been extremely disruptive to the business on top of an already challenging operating environment. Thanks to everyone connected to McDonald’s brands for your dedication and commitment to the business as well as your efforts to keep everyone safe during this volatile time. I’ll now turn it over to Ian.

Ian Borden: Thanks, Chris, and good morning, everyone. As Chris mentioned, the second quarter was yet another demonstration of consistently strong performance, guided by our Accelerating the Arches strategy and fueled by our outstanding execution. We’re delivering delicious feel good moments to our customers in new and exciting ways by doubling down on our creative excellence and highlighting our core menu, all with the value and convenience our customers expect. Our performance speaks for itself and is a testament to the passion and dedication of our entire McDonald’s system. With global comparable sales of 11.7% and consistent performance across our segments, it’s clear that the McDonald’s brand has never been stronger. In fact, the brand was at the center this quarter as we engage with customers in authentic and culturally relevant ways with campaigns rooted in consumer insights.

As Chris touched on a few minutes ago, we took the nostalgic experience of celebrating birthdays at McDonald’s and repackaged it for a new generation with none other than Grimace at the center. It quickly became one of our most socially engaging campaigns of all time with millions of reactions on our social media posts, a true demonstration of how the power of our brand emerges in organic and creative ways in our fans. It contributed to the strong double digit comparable sales growth for the quarter in the US. The passion for the brand was also evident in Italy with the launch of a truly unique creative platform. It celebrated the most loved and best selling beef burger in the market by asking customers, what would you do for a crispy McBacon?

The answer came in the form of customers getting tattoos of their favorite McDonald’s sandwich, driving brand affinity and elevating share gains. I’ve certainly seen a lot in my 30 years at McDonald’s but this was a new one for me. Truly remarkable. As I’ve mentioned before, our chicken equities remain at the core of our growth strategy. The UK celebrated the 40th anniversary of another fan favorite, the Chicken McNuggets, by offering limited time sauces to reconnect with the Gen Z consumer. This was coupled with compelling media that showcased the fan truth that sharing your nuggets isn’t guaranteed, even if your best friends. China also highlighted the Chicken McNuggets anniversary in a creative way with an integrated marketing campaign.

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Featuring our 20-piece nuggets, it quickly went viral on social media and generated significant positive buzz among consumers. Spicy McNuggets, one of our most popular line extensions, were offered across various markets this quarter, including Australia and Germany. It is yet another example of how we modernize our core menu, adapt it to meet changing customer taste profiles and scale these new ideas across the globe. Both markets achieved significant lifts to the McNuggets line as a result and Spicy McNugget sales reached an all time high in Australia. Our ambition on chicken includes further scaling emerging equities across markets. The McCrispy Chicken Sandwich, for example, has now scaled to over 10 of our largest markets, including Spain just this past quarter.

The sandwich is already resonating with our customers, bringing attention to our chicken portfolio and driving significant chicken share gains. A recent addition to our portfolio of billion dollar brands, the McCrispy continues to be an important catalyst of chicken growth for many of our markets. The UK, for example, has achieved market share leadership in chicken, a remarkable growth over the past few years with the launch of both the McCrispy and the McSpicy Chicken sandwiches. We look forward to further scaling these new global favorites to customers around the world. A challenging macro environment including rising interest rates and elevated costs continues to create volatile consumer confidence levels and put pressure on consumer spending.

Providing customers with an affordable option has always been core to McDonald’s. But in these challenging times, it is even more important for us to remain agile, proactively meeting the needs of our customers. Germany continued the success of its McSmart menu. Initially introduced last quarter to provide entry level affordable meals, it’s contributed to our best sales quarter ever in the market and lifted value perceptions with consumers. The UK unveiled a similar offering with its new Saver Meal deals in June, and the early results are encouraging. A permanent addition to the menu, it aims to provide consistent everyday affordability and ensure customers can still enjoy their favorite treats like the Double Cheeseburger despite the rising cost environment.

Maintaining our leadership position in value is crucial to future success, and McDonald’s holds the number one position in good value for money and affordability across most of our major markets. This shows that even in the most challenging of environments, our customers know that they can rely on McDonald’s to provide an affordable destination for the food that they love. But we know that customers’ perceptions on value are made up of more than just the price of our food. It’s also about the experience that we provide. We’ve continued to enhance the customer experience, providing the seamless and memorable interactions our customers have come to expect. Last quarter, we introduced an enhanced ordering process through our app in the US with the goal of delivering a faster and more enjoyable experience for the customer.

While we’re still learning from this deployment, early results have been extremely positive with elevated sales initiated through the app, increased customer satisfaction and improved service times. Canada also introduced new experiences in the app with the launch of the Frequent Fryer program. Tapping into Canadians’ passion for travel, the digital campaign celebrated McDonald’s fries and the opportunity to taste them in other countries. This creative approach to reengage with our loyalty members resulted in lifts to both digital acquisition and digital customer frequency during the campaign. Now in over 50 markets across the globe, we’re continuing to build stronger relationships with our loyalty customers and fueling growth of our digital sales in the process.

In our top six markets, digital sales represent nearly 40% of system wide sales and our loyalty members remain highly engaged with over 52 million 90 day active members across our top six markets. As our relationships with these customers continue to grow, we will unlock additional customer needs and explore investments for continued digital innovation at a scale that only McDonald’s can achieve. Strong execution across all elements of Accelerating the Arches is creating additional customer demand and share gains across most of our major markets. But we recognize that we’re operating in a challenging macro environment where costs remain elevated, customer discretionary spending is limited and industry traffic is pressured. In line with industry trends and as inflation begins to normalize later in the year, we expect top line growth to moderate.

Turning to the P&L. Our strong top line performance across each of our segments drove adjusted earnings per share of $3.17 for the quarter, an increase over the prior year of 25% in constant currencies, excluding other charges and gains in both periods as well as a prior year tax settlement. Our company operated margin performance for the first half of 2023 is in line with our expectations and remains hampered by continued cost pressures. As we look to the remainder of the year, we expect macro headwinds will continue. Total restaurant margin dollars grew by nearly $450 million in constant currencies or nearly 14% for the quarter. Strong franchise sales performance continues to be offset by targeted and temporary franchisee assistance, provided mainly to our European franchisees where elevated costs continue to pressure restaurant cash flows.

We’re still anticipating that these efforts will have an impact of $100 million to $150 million for the year. G&A for the quarter decreased 6% in constant currency, primarily driven by prior year costs incurred for our worldwide convention last April and timing of anticipated current year spend. We are pleased with our strong adjusted operating margin of just over 47% for the first half of the year. This was driven by the continued strong top line growth that I mentioned and timing within our G&A spend. For the full year, we now expect adjusted operating margin to be about 46%, reflecting heavier G&A spend in the back half of the year, along with an expected property gain in other operating income in quarter four. And our adjusted effective tax rate was just over 18% for the quarter.

And with that, let me turn it back over to Chris.

Chris Kempczinski: Thanks, Ian. As I’ve said before, McDonald’s Corporation is in the business of selling a brand. Our investments through Accelerating the Arches to create cultural conversations and develop industry leading innovations have increased the value of our brand and kept us relevant. In June, McDonald’s earned an impressive 18 lions across 10 markets at the Cannes Lions International Festival of Creativity. Additionally, our team in the UK and Ireland was awarded the prestigious Marketing Society’s Grand Prix, which recognizes the best marketer in the country. The McDonald’s brand also rose to the number five spot in the 2023 Kantar BrandZ Top 100 Most Valuable Global Brands report, behind only the leading tech industry brands.

As we’ve upped our marketing game, it’s also been interesting to see how our food quality scores with customers have continued to increase. The more customers love our brand, the more they love our food. Beyond the great brand stories created by our marketing teams and agency partners are the thousands of franchisees around the world who create real life brand stories every day in the restaurants with our customers. Our franchisees and crew bring the McDonald’s brand to life with great hospitality, convenience and service. The best brand in the industry backed by the best franchisees has been our value creation formula for decades. We’re always looking ahead to what is next and asking ourselves, how do we continue to create the world’s greatest franchising opportunity for the world’s greatest franchisees for generations to come.

This requires making decisions for the long term to earn our success rather than expecting it or assuming it. Our Accelerating the Arches strategy is focused on just that, setting up the company and our franchisees to continue to prosper. Laying the foundation for the future also involve strongly defending the franchise system and independent ownership rights, a position echoed by the National Franchise Leadership Alliance, the elected representative voice of McDonald’s franchise organizations across the US. I’m confident that the system is focused on the right priorities and is well positioned to meet the customer needs of tomorrow. Thank you to the over 2 million talented people working in our restaurants, our thousands of franchisees and our entire network of suppliers around the world who bring the McDonald’s experience to life each day.

I’ll now turn it over to Mike for Q&A.

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Q&A Session

Operator: [Operator Instructions].

Mike Cieplak: Our first question is from Eric Gonzalez with KeyBanc.

Eric Gonzalez: My question is about your expectations for the US consumer. I think last quarter, there was some discussion about your base case that the US would expect a mild recession. And I think you called out that you’re starting to see some evidence of trade down in your check management at that time. So I’m wondering, has there been any change in your current thinking and whether those consumer behaviors have intensified or moderated in the last quarter.

Chris Kempczinski: I’d say, overall, there hasn’t been dramatic change in the US consumer. Sentiment is actually improving a little bit but we’re certainly still far off of where we were back in 2019. As we look at our spend by different sort of economic cohorts, we are gaining share in the — if you look at incomes under $100,000, we’re actually doing quite well there, which suggests that we’re getting some benefit from trade down, from things like full service dining, casual dine, et cetera. And then even if you go to incomes of $45,000 and less, our business is performing well there. What we’re seeing with that group is we are seeing a little bit of a decrease in order size, but it’s being offset by a very strong or continued strength in traffic.

So I think net-net, when you look at all of it, there is certainly concern with the US consumer that shows up in their sentiment. But our business and particularly I think our value positioning in the market has put us into a good position to be able to weather that and continue to drive the share gains that you’re seeing.

Ian Borden: I just might add a little bit to Chris’ comments. I think we’ve talked — if I just focus on the US over the last couple of quarters about kind of these two broad areas of probably consumer adjustment that we’ve seen. I would say the first one is we are seeing some consumers that are kind of trading down from those more premium or higher priced items in the menu to more core and value. And then I think as Chris said, we have consumers that continue to visit but probably are just buying a little less. So their basket sizes are a little bit smaller than what they’ve been previously. I think the context is those two factors, though, have been really, while they’ve been in play for a number of quarters now, have been very consistent.

So we’re not seeing any further kind of deterioration, I think that, which is encouraging. And as Chris touched on, I think, speaks to our leading value for money and affordable positioning in the US business, which we know is industry leading and where we’ve maintained a really strong gap to the competitive set. I mean, I think it is — I think the consumer still remains under pressure, obviously, with the macro context, with all of the inflationary impacts that they’re seeing on their kind of their basket of goods and obviously with rising interest rates, But we know we had obviously positive traffic growth in the quarter in the US business. We know that on a comp basis, we continue to outperform the broader sector. And I think as Chris touched on in his opening remarks, we continue to focus on the experience and we know based on the feedback that we’re seeing from our customers that we’re delivering an improved experience.

I think that’s a credit to the US business and all of our franchisees and the really strong focus they’ve got on executing and make sure we deliver for the customer when they do choose us.

Mike Cieplak: Our next question is from David Tarantino with Baird.