McDonald's shares rise 6% as menu price increases, global growth fuel earnings beat

Key Points
  • McDonald's beat earnings on the top and bottom line Tuesday.
  • In the third quarter, McDonald's posted its 13th consecutive quarter of positive same-store sales growth.
  • McDonald's shares are down more than 3 percent since the start of the year, as of Monday's close.
A lot of change going on for McDonald's and you're seeing that in the margins, says analyst
A lot of change going on for McDonald's and you're seeing that in the margins, says analyst

McDonald's shares rallied Tuesday on a better-than-expected third-quarter report, which showed a strong performance in international markets and higher spending per customer in the U.S.

Value deals in the U.S., including a revamped Dollar Menu, helped bring in customers, but the larger tickets prove diners are willing to spend a little bit more. Restaurant owners are still looking for a stronger pickup in customer traffic from efforts the company is making to revitalize its restaurants. However, the solid performance outside the U.S. was encouraging. Many of the international markets have already made some of the changes that are being rolled out in the U.S.

Shares of the company were up about 6 percent in trading Tuesday, on pace for its largest percent increase since October 2015.

Here's what the company reported compared with what Wall Street was expecting, based on a survey of analysts by Refinitiv:

  • Adjusted earnings: $2.10 per share vs. $1.99 per share
  • Revenue: $5.37 billion vs. estimates of $5.32 billion
  • Same-store sales: 2.4 percent growth in the U.S., in line with estimates, according to StreetAccount

Still, earnings and revenue both declined from a year ago, as McDonald's refurbishes restaurants and adds upgrades such as self-order kiosks and table service. The company also has tried to improve its menu, including adding fresh beef hamburgers and new coffee drinks, and partnered with Uber Eats on delivery to bring customers back.

But these upgrades aren't boosting revenue and earnings fast enough to satisfy some franchisees. A quarter of its U.S. restaurant operators met earlier this month and are considering banding together to push for more support from the company.

But the company continues to support its plans. "We remain confident that our strategy will drive long-term, profitable growth," CEO Steve Easterbrook said in a statement.

Sales at McDonald's locations that are undergoing these changes have typically fallen 30 to 40 percent during the construction phase, David Palmer, analyst at RBC Capital, said on CNBC's "Squawk on the Street" Tuesday.

"The sales and guest count recovery period after we complete a project has also been a little inconsistent," Kevin Ozan, McDonald's chief financial officer, said on an earnings conference call Tuesday. "So we've put processes in place to execute strong grand reopening plans after construction that involve our local communities."

Palmer said that overseas, McDonald's has already done a lot of these restaurant updates and digital initiatives and it's paying off. Same-store sales in its international lead markets — U.K., Australia and France — were up 5.4 percent in the quarter, better than the 4.1 percent analysts had expected, according to StreetAccount.

McDonald's renovates around 1,000 stores per quarter in the U.S. and plans to spend about $1.6 billion domestically in 2018, with the majority of those funds going toward accelerating the pace of these remodels.

At this pace, the company expects to complete more than 12,000 restaurants by the end of 2019, Easterbrook said on the call.

"This is the largest construction project in our history," he said. "We still have hard work ahead, but we are seeing encouraging response from customers in restaurants where many of these improvements already completed. This is in line with our experience in other McDonald's markets such as Canada, the U.K., and Italy that executed programs several years ago that were similar to the one the U.S. is undertaking now."

Although McDonald's provides some financial assistance to franchisees, much of the burden falls on them.

"This is a price that they are willing to pay so long as they see results in the form of better sales and profits. However, now these benefits are coming through more slowly, many are starting to question the strategy," said Neil Saunders, managing director of GlobalData Retail, in a statement.

Net income in the quarter fell 13 percent to $1.64 billion, or $2.10 per share, down from $1.88 billion, or $2.32 per share, a year ago. This exceeded analyst expectations of $1.99 per share, according to Refinitiv.

The company said foreign currency exchange rates reduced its earnings per share by 5 cents in the latest period.

Revenue fell 7 percent to $5.37 billion from a year ago, exceeding analyst forecasts of $5.32 billion.

Same-store sales at McDonald's rose 4.2 percent globally in the quarter, compared with analyst expectations of 3.6 percent, according to StreetAccount.

In the U.S., same-store sales grew 2.4 percent, in line with analysts' forecasts, marking the 13th consecutive quarter of positive same-store sales growth.

The combination of a 2 percent rise in menu prices as well as delivery and self-order kiosk orders contributed to a higher average check domestically, Ozan said. While sales were positive, U.S. guest counts declined in the third quarter, due to increased competition with other restaurants offering value deals, he said.

"In our opinion, the changes McDonald's is making are right and will pay dividends over time," Saunders said. "Indeed, a failure to change would be disastrous. However, the challenge is to ensure that sales growth comes through at a faster pace and that costs are moderated to counterbalance the investment."

In a filing with the Securities and Exchange Commission, McDonald's said it now expects commodity prices to rise 2 percent, the top end of its previous guidance.

Watch: Why McDonald's and Burger King are failing in Vietnam

Why McDonald's and Burger King are failing in Vietnam
Why McDonald's and Burger King are failing in Vietnam