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McDonald’s Q2 earnings are ‘really good news in this environment,’ analyst says

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BTIG Managing Director and Restaurant Analyst Peter Saleh joins Yahoo Finance Live to break down McDonald's earnings and the outlook for the fast food chain.

Video Transcript

- Shares in McDonald's on the move this morning, up about 1.75% after reporting an earnings beat for the second quarter before the bell. You can see missed on the top line, but did beat on the bottom line. All of this happening as the rising cost of food and consumers trading down to value items due to surging inflation.

For a little bit more on the breakdown from this morning's report, let's bring in BTIG's restaurant analyst Peter Saleh for more on the report. And also with us is Yahoo Finance's Brooke DiPalma. Peter, give us the breakdown on what you saw in here. It's an interesting story where they're experiencing the higher cost of the inputs, but maybe people will be trading down to eat more McDonald's in this recessionary environment. What did you see as the green shoots for this company?

PETER SALEH: Yeah, great. So thanks for having me on. Look, I think it's definitely better than feared. I mean, if you look at their same-store sales on a global basis, they improved sequentially on a two-year stock basis and a three-year stock basis from 1Q into 2Q. If you look at the US number, you see that sequential acceleration on a one, two and three-year stock basis.

So I think it relieved some fears that consumers were really slowing down. We were hearing going into the quarter that the US comp was improving from March into April into May and into June. So I think it's rather healthy, and I think, in this environment, where we continue to hear record gas prices, record inflation, for them to have essentially flat traffic and a beat on same-store sales of 3.7%, I think that's really good news in this environment.

BROOKE DIPALMA: And Peter, to jump off of that, drive-through percentages are pretty much back to where they were pre-COVID. Delivery still a bit elevated to where it was pre-COVID. How much of an impact do you think that those fuel prices have on consumers getting out and, say, going to their local McDonald's?

PETER SALEH: Look, I mean, we've looked at this in terms of fuel price rising and the impact on traffic and same-store sales. We've looked at it every which way we could find. And historically, we've never been able to find any real correlation between rising gas prices or declining gas prices and same-store sales or traffic. I think it's really mostly correlated with income growth and job growth, is what we've found historically.

And right now, we continue to see more jobs being created. There's a shortage of labor and incomes are rising, as is inflation. So I don't think the inflation in fuel prices is going to have a long-term effect right now on the same-store sales. And we're not seeing it even near-term.

- So Peter, let's talk about the impact to McDonald's when we talk about inflation. Obviously, they're having to deal with higher food costs, but also higher labor costs, too. And it certainly doesn't feel like that's going away anytime soon. How does it cloud-- how does that cloud the outlook for the company? How do you see those factors weighing?

PETER SALEH: Yeah, look, that's-- it's true, I mean, we're seeing a lot of commodity inflation, call it low to mid-teens commodity inflation, double-digit labor inflation. It's across the entire industry. It's not just specific to McDonald's. Every restaurant is seeing it. But we're also seeing that at grocery store prices, as well. They're going up.

But the bottom line is, the one real lever these restaurants have and McDonald's has is raising price. And they've been doing so. And it's all about timing and when you raise price. And prices have been going up, we're hearing on McDonald's, 8% to 9%, in some cases. In other restaurants, it's a little bit higher. In some cases, it's a little bit lower. But that's what they've got to do to offset this inflation.

If you look at the margins, the margins actually improved from first quarter to second quarter, despite the fact that inflation accelerated. So overall, they're managing it well, despite the fact that we've got this record inflation. And that's really going to continue into the third quarter, before it moderates in 4Q and maybe into 2023.

BROOKE DIPALMA: And Peter, on the call this morning, executives used the buzzword of recession many times over, saying that they continue to hope to provide affordable options. If that is the case, now for our audience of investors here, do you think, should a recession happen, that McDonald's could be a recession-proof stock?

PETER SALEH: So, you know, historically, I think consumers cut spending on restaurants early, before you go into a recession, or right at the tip of a recession. So we're not seeing that, I guess, at this point. And look, I think for McDonald's specifically, I think, you know, one franchisee put it best, you know, in recessionary environments, they do well because people want to gravitate towards familiar brands, brands that they trust that are going to do right on the pricing and the value orientation. So I think, yeah, this is probably one where investors are, to a certain degree, hiding in the name because it does tend to perform a little bit better in downturns.

- Peter, the labor story very interesting, as well. We know that was a big reason why margins are getting a little bit more difficult for these types of companies. But they're trying to do drive-through voice ordering now. This is a test thing, right, but do you think this is going to be pretty important for their automation efforts over at McDonald's?

PETER SALEH: So absolutely. I think the point of ordering in the drive-through is where the bottleneck is. It's not from the kitchen. So I think if you get the voice ordering down-- I mean, the accuracy is improving every day, and the computer never forgets to try and upsell you. So if they get that technology working, I think they can improve service times pretty meaningfully. And really, with that, you can improve same-store sales.

So I think the technology is almost there. We're hearing some varying things about the accuracy. Some franchisees are telling us, we're hearing 95% plus accuracy. Others are saying it's in the low 80s. We think once that gets up into the-- consistently up above 90%, 95% order accuracy, I think you'll see it deployed across the system more meaningfully.

- Peter, you've got a $280 price target on the stock. Certainly a little upside to where we are right now. What do you think is going to be the biggest driver here, and how much of this is really contingent on McDonald's being able to keep up with those higher costs you alluded to by adjusting their prices?

PETER SALEH: Yeah, well, I mean, clearly the biggest driver is going to be same-store sales. I think the loyalty program is also working to drive new customers and feed them a lot more information about how their customers use their brands. So I think those two will be the drivers here to get us. But I also think, you know, once we start to-- inflation is starting to peak. I think 3Q will be-- look similar to 2Q, but once we get into fourth quarter and inflation starts to come down, I think you could start to see the stock really move higher if same-store sales are holding up while inflation's coming down.

- OK, we'll be watching that one closely. Peter Saleh, restaurant analyst at BTIG, always good to have you on the show. Appreciate your time. And our thanks to Brooke, too, for joining in on the conversation.