McDonald’s extends long string of quarterly gains, though beef costs could be a problem

October 21, 2011 11:47 AM3 commentsViews: 24

McDonald's extends long string of quarterly gains, though beef costs could be a problem

NEW YORK, N.Y. – McDonald’s Corp.’s third-quarter net income rose by 9 per cent as it kept defying a tough economy and attracting more customers. But those diners might want to get ready to pay more.

The world’s largest hamburger chain, which has performed well throughout the recession and its aftermath, noted potential challenges like the rising cost of beef and higher labour costs. McDonald’s, a bellwether for the rest of the fast-food industry, hinted that it could raise menu prices for the third time this year.

Companies of all stripes, from restaurants to clothing makers, raised prices this year as the cost for many raw materials spiked, and it appears that more increases are coming. For McDonald’s that means the beef in its burgers, the grain in its buns and the coffee in its lattes.

But companies know that they still have to be careful to not raise prices too much and drive away customers, who are choosing carefully where to spend their money.

“The economists say we are officially out of the recession, but it hardly feels that way,” CEO Jim Skinner said in a conference call with analysts. He referred to McDonald’s gains as “hard-won” victories.

The 9 per cent rise in net income, to $1.51 billion, represents McDonald’s ninth straight quarter of earnings gains. Earnings per share of $1.45 beat analysts’ expectations of $1.43. A 14 per cent increase in revenue, to $7.17 billion, also beat the $7.02 billion predicted by analysts polled by FactSet.

McDonald’s success has hinged on quickly adapting to customers’ changing tastes and reshaping itself as a hip, healthier place to eat. It has added menu items like smoothies and oatmeal, remodeled restaurants, and converted more locations to 24-hour operations. All those moves, the company says, have brought in more customers.

The company didn’t give details about possible price increases, though Skinner said that keeping prices affordable was “paramount.”

We will continue to evaluate additional price increases in light of this inflationary environment, always balancing our goal of driving traffic and market share gains with managing impact of rising costs,” said Chief Financial Officer Peter Bensen.

The company’s U.S. commodity costs spiked 8 per cent this quarter compared to a year ago. That’s higher than the 6 per cent in the second quarter and the 1 per cent increase in the first quarter.

The cost of beef, which normally declines at the end of the summer grilling season, stayed high, which McDonald’s hadn’t expected. The U.S. Department of Agriculture now predicts that consumers will end up paying 8 or 9 per cent more for beef and veal in 2011 compared with 2010.

McDonald’s has already raised prices to offset the higher ingredient costs, raising menu prices by an average of 1 per cent in March and another 1.4 per cent in May. Bensen said the company had experienced good “flow through” on the two price increases, meaning they hadn’t driven away customers.

Grocery prices, which are increasing at a faster clip than restaurant prices, could also give McDonald’s some room to raise prices because customers could view eating in as less of a value.

Beef wasn’t the only expense to rise. McDonald’s effective tax rate climbed because of some lower foreign tax credits. Labor costs rose, and the company invested in new restaurant openings in China, where it now has about 1,400 locations. “Almost every category of costs is going in the wrong direction,” Bensen said.

The store openings in China, where it hopes to have 2,000 locations by the end of 2013, signal McDonald’s strategy to invest in emerging markets as the U.S. economy continues to struggle. The U.S. accounts for about 31 per cent of McDonald’s total revenue.

Customer spending at McDonald’s franchised and company-owned restaurants rose 5 per cent, while in Europe, the company’s largest market, the figure climbed 16 per cent, and in Asia/Pacific, the Middle East and Africa 20 per cent. The foreign gains were helped by the impact of currency translation — when the dollar weakens, money made in other countries translates into more dollars in the U.S. — but even without that effect, the gains outpaced the U.S. revenue growth.

Those figures don’t reflect McDonald’s corporate revenue, which consists of revenue at company-owned restaurants plus fees and rents paid by franchisees.

Investors sent McDonald’s shares up about 3 per cent in the early afternoon, to $91.60.

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