McDonald’s Corporation (NYSE:MCD) Q4 2022 Earnings Call Transcript

McDonald’s Corporation (NYSE:MCD) Q4 2022 Earnings Call Transcript January 31, 2023

Operator: Hello, and welcome to the McDonald’s Fourth Quarter 2022 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. . 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 our 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 reenter the queue for any additional questions. Today’s conference call is being webcast and is also being recorded for replay via our website. And now, I’ll turn it over to Chris.

Christopher J. Kempczinski: Thank you and good morning everyone. When we gathered at this time last year we expected 2022 to be a year of recovery from the pandemic particularly in Europe. Little did we know there would be another challenging year and nobody could have predicted the extent to which the war in Europe would disrupt businesses around the world and the macroeconomic impact that would follow. Despite continued volatility in nearly every corner of the globe, McDonald’s delivered exceptional growth throughout 2022. We achieved full year comp sales growth of 10.9%, delivered strong guest count performance with 5% growth globally, and saw our momentum strengthen as the year progressed with double-digit comp sales growth across all segments in Q4.

These results are a testament to the resilience of the McDonald’s system and demonstrate that our Accelerating the Arches strategy which we unveiled in the early days of the pandemic is working. This strategy is anchored by three growth pillars also known as our M, C, and D’s, maximize our marketing, commit to the core menu, and double down on the 3Ds. Our 2022 performance demonstrated that continued potential of each growth pillar. You have heard me say McDonald’s is one of the world’s greatest growth pillar. You’ve heard me say McDonald’s is one of the world’s greatest brands. In the last year, we’ve unlocked even more ways to elevate our marketing through creative excellence. Our scalable insights are helping us tap into our fans love for McDonald’s and create culturally relevant campaigns that resonate across markets and drive growth.

That momentum continued into Q4. In October, our collaboration with Cactus Plant Flea Market in the U.S. brought together our adult fans love and nostalgia for the Happy Meal with one of the most on trend brands and culture. Customer excitement was palpable and it’s fair to say the program exceeded expectations. This program drove the highest weekly digital transactions ever seen in the U.S. To celebrate the FIFA World Cup, we launched our largest global marketing campaign ever with more than 75 markets participating worldwide. Want to go to McDonald’s? Brought to life yet another fan truth, whatever the culture or language and whatever the outcome of the game, we can all unite under the Golden Arches. Our aim was to support fans that were watching the FIFA World Cup at home through relevant and meaningful McDelivery promotions, regardless of the time zone that their team was playing in.

During this campaign we saw double-digit increases in delivery sales across our top ten markets. And just a couple of weeks ago the UK launched their Raise Your Arches campaign which has generated significant excitement with our customers. Even though the campaign never shows our food, never shows our restaurant, and never mentioned our brand name, it’s nonetheless instantly recognizable as only McDonald’s. Imagine that, a brand so powerful it requires no introduction. The campaign has been quickly picked up by over 30 other markets, demonstrating our systems ability to quickly scale compelling ideas across the globe. Throughout 2022, some of our most successful campaign platforms brought our customers closer to the core menu items they love.

The strength of our brand goes beyond the Golden Arches themselves and includes our iconic products such as our world famous French Fries, the Big Mac or Chicken McNuggets and the McFlurry. Each of these products are billion dollar brands and in total, McDonald’s possesses ten of these billion dollar brand equities. In an environment where our customers are looking for the simple and familiar, our core menu items have never been more relevant or beloved. Throughout the year, we continue to step up our game on the favorites that build our heritage. We’re delivering hotter, juicier, more delicious burgers and building on the success of emerging equities like the McCrispy Chicken Sandwich. As a result, we are gaining market share in both chicken and beef.

When customers want to enjoy our classic favorites, they are increasingly looking for even more personalized and convenient ways to get their meals. Through our focus on digital, we are transforming from a brand that serve billions and billions all the same way to one that serves each of our billions of customers uniquely as individuals with customized products, offers, and experiences. By doing this, we strengthen our customers love and loyalty for McDonald’s. These investments are paying off. In the fourth quarter, digital represented over 35% of system wide sales in our top six markets. In 2022, the McDonald’s App was downloaded over 40 million times in the U.S., greater than the total downloads of the 2nd, 3rd and 4th brands combined. Through our loyalty program, which we’ve expanded over 50 markets and counting, customers are feeling more connected to McDonald’s, which in turn increases visits and frequency.

As we closed the year, we had almost 50 million active loyalty users in our top six markets. The success of Accelerating the Arches has put McDonald’s in an advantage position. Since the start of the pandemic, we’ve grown system wide sales nearly $20 billion despite closing over 800 restaurants in Russia. Our brand is clearly in the strongest position it’s been in years, attributable in part to our best in class marketing engine. And service times and customer satisfaction are both improving, a testament to the dedication of our restaurant teams. Our success is fueling even greater ambitions. While we feel good about our strategy and the growth potential in each of our McD pillars, we’ve been asking ourselves two questions, is there anything we should add to Accelerating the Arches and is there anything that could get in the way of the success of Accelerating the Arches?

The answers to these two questions lead us to evolve our Accelerating the Arches strategy, which we announced a few weeks ago. We’ll continue to double down our McD’s while adding a fourth D, restaurant development to our 3D’s growth pillar. Our strong comp and brand performance has given us the right to build new units at a faster rate than we have historically. We also announced accelerating the organization, an effort to modernize the way we work so that we’re faster, more innovative, and more efficient. Work is now underway to further build out these initiatives and quantify their contribution to our long-term financial algorithm. We’ll share more details with all of you at an investor update in Chicago sometime in late 2023. To expand further on how Accelerating the Arches drove success in 2022, I’ll now turn it over to Ian.

Photo by Amandine Lerbscher on Unsplash

Ian F. Borden: Thanks, Chris. By putting our customers at the center of Accelerating the Arches, we’re driving top line momentum and broad based global strength for our brand. Global comparable sales were up double digits for the fourth quarter, and we continue to gain share across most of our major markets. Our performance is a direct result of executing against our strategy, making it clear that we’re operating from a position of strength and proving once again that our business remains resilient despite the dynamic macro environment. In our international operated markets, we leveraged our digital channels and highlighted our core menu delivering comp sales growth of nearly 13% for the quarter. As our big five international operated markets continued to recover from COVID throughout the year, we consistently created delicious feel good moments for our customers, achieving strong performance across each of these markets.

The UK continued their focus on chicken with an early fourth quarter launch of the McCrispy Chicken Sandwich. This emerging global equity builds on iconic core favorites like Chicken McNuggets and drove a meaningful lift to the chicken category. The UK market also leaned into the power of our brand with the popular Reindeer Ready holiday campaign returning for the sixth consecutive year. The fourth quarter also brought the return of McDonald’s monopoly to the Canadian market, but this time utilizing our app to elevate the experience. We leveraged learnings from recent UK and Australia activations, where we combine the nostalgic peel off game pieces with the option to digitally scan and track progress on our app, which helped accelerate top line momentum and sales through our digital channels.

Fueling digital growth was also central to Germany’s strong performance with the market’s first My McDonald’s branded affordability campaign. This promotion featured daily offers alongside mobile order messaging to drive full digital platform engagement. It was followed by the launch of Digital Monopoly in the market, which helped grow digital to over 60% of total sales. It’s examples like this that once again highlight the power of the McDonald’s system, allowing us to tap into proven successes in one market and then scale those ideas. In Australia, we continued to leverage the strength of our McCafé brand with an iced coffee promotion in the summer months. This campaign built upon our coffee leadership in the market as we continue to drive share gains.

And we maintained our market leadership in France with always on family messaging and a fully integrated chicken campaign highlighting our iconic chicken McNuggets paired with unique and trendy sauces. Moving to the U.S., comp sales were up over 10% for the quarter, a testament to our work together with franchisees over the last several years, which has created a strong foundation. The collective decisions to put brand at the center of our marketing, along with simplifying our menus, strengthening our digital business, and recommitting to our core have resonated with consumers and are continuing to drive growth. Strategic calendar planning from marketing to restaurant execution has enabled our teams to stay laser focused on what truly matters most for our customers.

Higher average check supported by strategic price increases as well as positive guest counts, contributed to our performance this quarter. Memorable marketing campaigns, including our collaboration with Cactus Plant Flea Market, Blue Buckets, and McRib brought nostalgia to our customers fueling top line momentum with limited added complexity in our restaurants. Turning to our international developmental license markets, comp sales were up over 16% for the quarter, with strong sales growth across all geographies in the segment. Japan achieved an impressive 29th consecutive quarter of positive comp sales with continued strength at the dinner day part. A focus on driving digital affordability helped increase the frequency of our most loyal digital customers.

Recovery in China, however, remain challenging as COVID related government restrictions were still in place for a majority of the fourth quarter, resulting in some temporary closures and limited operations. While comp sales in China were negative, we focused on showcasing our strength in beef with the Big Mac Best Burger launch and continued to gain traffic share in a shrinking QSR market. And despite the ongoing operating challenges, we opened over 700 new restaurants last year, which is an all-time high. Turning to our P&L, company operated margins were just over 15% for the quarter, reflecting the continued pressure from elevated commodities, wages, as well as higher energy costs. Foreign currency translation negatively impacted fourth quarter results by $0.16 per share, with earnings per share of $2.59 for the quarter.

For the full year, adjusted operating margin was nearly 45%, reflecting higher restaurant margin dollars across all segments. Despite the significant P&L pressures that we’ve discussed, top line results generated restaurant margin dollars of over 13 billion for the year, an increase of nearly 1.5 billion in constant currency. Franchise restaurants, which now represent 95% of our global portfolio, contributed nearly 90% of our total restaurant margins, reflecting the stability of our business model. Lastly, before I hand it back over to Chris, I want to touch briefly on our capital expenditures and free cash flow profile. Our CAPEX spend for the year was approximately 1.9 billion, which included remaining reinvestment to substantially complete our experience of the future efforts in the U.S. market.

Over the last few years, we’ve invested billions of dollars in modernizing our estate, and it’s clear in our results that these investments are paying off. After reinvesting in the business, our free cash flow conversion was nearly 90% for the year. And with that, let me pass it back over to Chris.

Christopher J. Kempczinski: Thanks, Ian. As we look ahead to 2023, macroeconomic uncertainties will persist and we expect to continue to face headwinds. Our base case for a mild to moderate recession in the U.S. and one that will be a little deeper and longer in Europe is unchanged from what we shared on our Q3 earnings call. We also expect inflationary costs to continue to pressure our margins, which Ian will discuss in greater detail. In this environment, we must maintain our disciplined approach to pricing. We need to balance passing through our pricing on our menus while maintaining our strong position on value with our customers. Our positive guest count performance in 2022 demonstrates our success so far in balancing these competing demands, and we need to remain judicious with pricing actions.

Ongoing communication with our franchisees regarding the magnitude and pace of pricing will remain essential. Our franchisees are focused on the long term and time and again that approach has been rewarded. As long as we continue to do the right things for the customer, we can always work through short term challenges. McDonald’s understands that customer’s perception on value is made up of more than just the price of our food. It’s also about the experience we provide. Our modernization efforts have had a significant impact on improving our customers experience, and this is also improving how our customers think of our brand. Now that we are nearly fully modernized, our attention is turned to being laser focused on our operations and running great restaurants.

In 2022, we reengaged most of our system on maintaining operational excellence in our restaurants through our Performance and Customer Excellence program, also known as PACE. This restaurant assessment and consulting tool, which is currently deployed in 30 markets, was suspended during COVID. Along with providing new tools, this represents a new way of working for our field teams that help us market target organizational and restaurant support for key growth drivers. This renewed focus will help protect McDonald’s brand standards for an outstanding customer experience every single day. Restarting PACE in 2022 led to strong operational improvements in several key markets as a result of a more dedicated consulting and coaching time to support lower performing restaurants.

For example, the UK saw improved customer satisfaction, speed of service, and overall experience for these restaurants. In Spain, restaurants that had the lowest customer satisfaction scores in the drive-thru improved to be at the same level as top-performing restaurants by the end of 2022. Additionally, as a result of this program, France saw increases of 30% in customer satisfaction scores at locations with the lowest scores. PACE clearly drives operational improvements, which provides a better customer experience that in turn drives business performance. This month, the U.S. also restarted PACE, and we expect to see similar operational benefits in our largest market in 2023. I’ll now turn it back to Ian to talk in more detail about our 2023 outlook.

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Q&A Session

Ian F. Borden: As Chris just discussed and as I talked about last quarter, we continue to operate in an extremely dynamic environment. Looking ahead to this year, we anticipate macro-related pressures will continue to weigh on both our consumers and our business. With significant inflationary headwinds across commodities, labor and utilities, our company-operated margin percent will be hampered in the near term, and we expect full year 2023 company-operated margin percent will be slightly lower than our quarter four results. This elevated cost environment is also impacting restaurant cash flow for our franchisees, particularly in our European markets. As we’ve previously mentioned, our financial strength and scale gives us the ability to provide temporary and targeted support, ultimately keeping our entire system aligned on proactively investing to drive long-term growth.

We estimate that these efforts will have an impact of between $100 million to $150 million in 2023. Turning to G&A, the digital and technology investments that we’ve made over the past few years have been strong contributors to our top line growth. Moving forward, focusing on our evolution of Accelerating the Arches, and in particular accelerating the organization, will enable us to work more efficiently and effectively, harnessing our scale and reallocating resources to drive growth in the future. In 2023, we expect G&A to be between 2.2% and 2.3% of system wide sales. Despite the cost pressures throughout the P&L in 2023, we anticipate an operating margin of about 45% driven primarily by strong top line growth and franchise margin performance.

We’re projecting interest expense this year to increase between 10% and 12% compared to 2022 primarily due to higher average rates on our debt balances. And we expect our effective tax rate for the year to be between 20% and 22%. We anticipate currency translation will negatively impact earnings per share of between $0.07 and $0.09 in the first quarter. As of now, we expect currency translation to be a slight tailwind for the full year but as you have seen, currency rates have been fluctuating quite a bit recently. So we’ll continue to keep you posted on the anticipated impact to our results. Transitioning to capital expenditures, we plan to spend between $2.2 billion and $2.4 billion this year, about half of which will be dedicated to new unit openings.

Globally, we plan to open about 1,900 restaurants with more than 400 of these openings in our U.S. and IOM segments, where we continue to see strong returns. The remaining 1,500-or-so new restaurants, including about 900 in China, will be across our IDL markets. As a reminder, our strategic partners provide the capital for these restaurant openings. Overall, we anticipate almost 4% unit growth from about 1,500 net restaurant additions in 2023. We expect this will contribute along with restaurants opened in 2022, nearly 1.5% to system-wide sales growth. As Chris mentioned, work is underway on our fourth D, restaurant development, within Accelerating the Arches. We’ll have more details to share later this year, but we’re excited about the opportunity to accelerate the pace of our new unit openings moving forward.

And finally, we expect to generate strong cash flow in 2023, enabling us once again to convert more than 90% of our net income to free cash flow. Going forward, our capital allocation priorities remain unchanged: first, to invest in new units and opportunities to grow the business along with reinvesting in existing restaurants; second, to continue growing our dividend; and third, to repurchase shares. It’s times like these that highlight the strength and scale of our McDonald’s system. Although 2023 will bring short-term pressures, I’m confident that the resilience of our business and our strategy will continue to deliver long-term growth for our system and our shareholders. Now let me turn it back over to Chris to close.