Juicy Profits for McDonald's

The fast-food chain says it's seeing strong demand overseas and for its low-priced menu

Despite a rare dip in U.S. same-store sales in March, fast-food giant McDonald's (MCD) reported strong first-quarter earnings thanks to robust overseas sales, the weak U.S. dollar, and success of its value menu. Many analysts think these trends will continue to fatten up profits this year.

On Apr. 22, McDonald's surprised investors by reporting that first-quarter profit rose 24% on a 31% rise in total sales. The Chicago-based restaurant operator earned $946.1 million, or 81 cents per share -- up from $762.4 million, or 62 cents per share, during the same period last year. Revenue rose 6% to $5.6 billion, beating Wall Street forecasts of a quarterly profit of 70 cents per share on revenue of $5.4 billion.

The U.S. dollar's decline is believed to have revved up profit by 5 cents a share, as the fast food chain operates more than 31,000 restaurants in 118 countries.

McDonald's shares dipped 0.6% to $58.35 on Apr. 22, as investors sold stocks on a heavy day of earnings news and record oil prices. McDonald's shares have traded has high as $63.69 and as low as $46.64 in the last year.

In a statement, CEO Jim Skinner said strong first-quarter results were "driven by comparable sales and guest count increases across all geographic segments and outstanding international operating performance." According to the company, it was "serving 2.5 million more customers per day compared with the same period in the prior year."

Among the fast growing international markets, European revenue rose 23% to nearly $2.4 billion, and in Asia, the Middle East and Africa the growth rate was 24% on revenue of $1 billion, with China and Australia leading the way.

In the U.S., same-store sales rose a more lackluster 2.9% in the quarter -- not surprising given the looming recession concerns. But the same-store sales drop in March of 0.8%, the first in five years and blamed partly on the early Easter holiday, did catch some off guard. "Frankly it is a big surprise to me," said analyst Larry Miller at RBC Capital Markets, who had forecasted 1.8% same-store sales growth for March. McDonald's is forecasting a rebound in April U.S. same-store sales.

Many restaurants find it hard to pass on high food costs to pinched consumers without losing sales these days. But so far, McDonald's seems to be able to keep prices low with its efficient food distribution system, while a weak dollar has helped boost sales for a globally known brand overseas.

Plus, McDonald's has a strong franchise system. McDonald's "is more isolated from the fluctuations and upward pressure on the cost side" as the chain-store operator takes out a flat fee from its franchise stores, says analyst Steve West of Stifel Nicolaus.

And while some Americans might be scaling back on expensive restaurants, many of them continue to flock to low-priced and fast-food chains. "Call us lazy or what, the fact is that Americans like to eat out. They spend 2% of their total income on eating in restaurants," West says. "The macro economic situation is a concern, but McDonald's is relatively recession resistant."

A late 2007 S&P survey of consumers suggested that high gas prices were worrisome to about half of the consumers surveyed. "We think this is contributing to lower traffic at full-service restaurants, particularly during the evening," wrote S&P Equity Research analyst Mark Basham in a research note. "Quick-service restaurants and limited menu chains may benefit, in our view, as consumers trade down from eating out at full-service outfits."

Though it's not clear how the rising food commodity cost worldwide and a weakening U.S. economy will hurt McDonald's profitability this year, some analysts remain upbeat about McDonald's strategy for the long run. "We believe MCD's solid execution of its 'Plan to Win' operating strategy has helped produce strong sales momentum over the past several years, and we expect healthy global sales results, albeit at a slower pace, to continue over the next few years," S&P's Basham wrote in a note on Apr. 21. (Basham has a buy recommendation on the shares.)

The company has decided to sharpen its focus in the U.S. on breakfast, chicken, and beverage items during fiscal year 2008, and is craving for a bigger share of the beverage market. In late April or early May, a nationwide campaign is under way to give away for free the southern style chicken biscuit and sandwich with a purchase of a medium or large beverage, according to a research note by Best Independent Research. McDonald's also has plans to open full-fledged coffee bars by 2009 with a line of frappes, smoothies, and other beverage options.

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