How a strong US dollar hurts McDonald's

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In recent months, McDonald's (NYSE: MCD) has been trumpeting the success of its "turnaround" strategy. However, a closer look at earnings reports reveals that a changing US dollar has been affecting revenue and profit. How exactly is this impacting the company? And what lesson can investors take away from a study of this?

A look at earnings and foreign currency
McDonald's "turnaround" strategy is being led by the launch of all-day breakfast and new value menu options. The company is also in the midst of refranchising restaurants worldwide, and has posted strong international sales and a rebound in bottom line profit. How has this been affected by the currency exchange issue?

McDonald's reported full year 2015 results back on January 25. For 2015, the company posted total sales of $25.4 billion and profit of $4.5 billion. Here is a table illustrating the results.

Metric

Fiscal Year 2015 Results

Percent Increase (Decrease) Over Fiscal Year 2014

Percent Increase (Decrease) Excluding Foreign Currency Exchange

Total Revenue

$25.4 billion

(7%)

3%

Net Income

$4.5 billion

(5%)

5%

Source: McDonald's Fourth Quarter 2015 Earnings Results

McDonald's reported a decrease in both revenue and net income for the year because of foreign currency exchange rates, but if those rates were excluded, the company has a 3% and 5% gain in revenue and net income, respectively.

How exactly does this work? If McDonald's sells a hamburger in Japan, it collects Japanese yen for that burger. The company now has to exchange the yen for dollars when it brings those proceeds back to the United States. If the dollar gains in value against the yen, when McDonald's exchanges the currency it takes a hit on that revenue it earned from the sale of the hamburger. Because the dollar appreciated against the Yen, it now takes more Yen to equal one dollar than it did before.

This is an important component of McDonald's business, and an important consideration for McDonald's investors. For fiscal year 2015, more than 75% of McDonald's revenue came from outside the United States. Most growth going forward is expected to come from business expansion overseas rather than from within the US. Foreign currency exchange is therefore an important factor for shareholders to bear in mind.

Over the course of 2015, the dollar increased in value against most world currencies. As we can see from the chart below, this ate into the top and bottom line for the world's largest hamburger restaurant. Here is a graphical representation of the strength of the dollar against a basket of other currencies compared with McDonald's revenue and net income when accounting for foreign currency exchange:

Chart created by author. Data source: Federal Reserve Bank of St. Louis and McDonald's 2011-2015 Annual Reports.

In the graph above, revenue and net income are measured on the left axis and the strength of the dollar is measured on the right. Over the last six years, McDonald's revenue and profit has seemed to move opposite to the moves in the dollar. The trend is particularly pronounced starting in 2014. The roughly 20% gain in the dollar starting that year corresponded to a double-digit drop in both revenue and net income, although net income has begun to rebound from its low point in early 2015.

Underlying all of this is the fact that, subtracting out the effects of foreign currency, McDonald's has been experiencing only single-digit growth rates in profit in recent years. This was noted earlier in the chart above, showing that subtracting foreign currency effects only yielded a 3% and 5% increase in revenue and net income, respectively.

What investors can learn
It is clear that McDonald's revenue and profit are greatly affected by moves in the dollar. A strengthening against global currencies has a negative effect, and a weakening has a positive effect. With more than 75% of revenue coming outside the United States, it is a big factor that cannot be ignored.

With a "turnaround" strategy that hasn't yet been completely realized, and the results of which are still unknown, I feel that the company's international exposure poses a large risk in the near term. Investors should be aware of this issue when assessing McDonald's, as the company's plan to return to growth could be derailed by this.

That being said, McDonald's is seeing strong growth in international markets, especially in Asia. Foreign currencies are always changing. If the US Dollar were to come back down in value, this would provide a boost to McDonald's revenue and profit. While I believe there are major headwinds for the world's largest hamburger joint in the immediate future, that international business should eventually take a turn for the better.

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