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McDonald's: Winning Over Europe

Swift sales overseas are boosting profits for this fast food company.



Do you know what they call a McDonald's Quarter Pounder with Cheese in France? A Royal Cheese. Why? Because France and most developed nations use the metric system, so customers may have a hard time picturing a hamburger that is a quarter of a pound instead of a 0.11 kilogram patty. This cultural sensitivity, which was famously highlighted in Quentin Tarantino's 1994 movie Pulp Fiction (which actually calls the hamburger a "Royale with Cheese") explains why McDonald's can be found on the Champs Elysée as well as nearly every major highway exit in the U.S. And lately, the world's biggest restaurant chain has generated strong sales and earnings overseas, especially in France and other European nations.

It's true that some Europeans will always despise the Golden Arches as a vulgar symbol of American economic hegemony. But the company is offering more local cuisine in its restaurants to win over the masses. You can order porridge in London, croissants in Paris and a McFarmer pork patty (for a limited time) in Berlin.

The home-grown strategy has paid off. On April 20, McDonald's announced that it earned 62 cents per share in the first quarter, up 27% from the same period a year earlier. Chief executive Jim Skinner singled out the European market as a big contributor to those results. McDonald's reported that March sales at European restaurants that have been opened a year or more were 11% higher than March 2006 sales.

The weakening greenback gives Mickey D's overseas operations a boost. "Foreign exchange impacts in 2007 should be more of a positive than previously thought," says A.G. Edwards analyst Steve West. He forecasts that continued strengthening of such currencies as the euro and British pound will increase sales in those markets by up to 2% and add several pennies to the company's earnings per share.

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But McDonald's is protecting itself from exchange-rate swings in more volatile currency markets through franchising. On April 20, the company announced that it plans to sell nearly 1,600 restaurants in Latin America and the Caribbean for $700 million to a licensee. The 20-year deal gives McDonald's a steady stream of franchise payments without the hassle of the overhead costs associated with owning the restaurants. The company wants to sell an additional 600 restaurants in other foreign markets.

The U.S. business is no slouch either. In March, McDonald's domestic operations posted its 48th consecutive month of positive comparable store sales. That's a streak the company has not achieved since 1980 and what West calls "perhaps the best four-year run in its storied history." But he thinks more is still to come. A jolt in sales from upgraded coffee and McDonald's popular Snack Wrap chicken sandwich will continue to generate growing profits. Plus, as rising gasoline prices squeeze consumers' pocket books, West expects that more people who want to dine out will visit McDonald's eateries rather than pricier restaurants.

Worries over higher commodity prices and U.S. labor costs appear overblown, West says. The relatively low beef, chicken and dairy prices restaurants have enjoyed over the past year should continue well into 2008, he says. West notes, too, that 85% of McDonald's U.S. operations are franchised, so the company is largely protected for rising labor costs.

McDonald's plans to share more of the wealth with investors. The company wants to use at least $5.7 billion to buy back stock and pay dividends in 2007 and 2008. It bought back more than $1 billion shares in the first quarter alone. And the company has increased its dividend 30 straight years.

McDonald's stock (symbol MCD), which closed at $48.95 on April 27, has climbed 45% over the past year. It trades at 18 times the $2.69 per share that analysts, on average, expect the company to earn in 2007 and at 17 times West's 2008 estimate of $2.85 per share. He thinks the shares are worth $54 and sums up his views on the stock this way: "Investors are still lovin' it and so are we."



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