McDonald’s Corp. (MCD) has been selling world’s most famous hamburgers since 1948. As the leading fast-food chain in the globe McDonald’s operated as of Dec 2013 more than 35,400 locations in over 120 countries, being its major markets outside the U.S., Australia, Europe, Brazil, Canada, China, France, Germany, Japan and the United Kingdom. Its revenues are generated through company-owned restaurants, franchise royalties, and licensing pacts. There’s no doubt this fast-food giant has a business model which has developed from the beginning with a growth pattern, operating with high sales and profitability, menu innovation, efficient operations, extended hours and, of course, strong brand recognition and customers’ acceptance.
Results though have been rather puzzling the past quarters, and McDonald’s fundamentals have weakened the past two years. The company saw the latest fourth-quarter a lower guest count, which decreased comps 0.1%. However, earnings were up and both the top and bottom lines were up year over year. In December, same-store sales in the U.S were down 3.8%, in January they were down by 3.3%, and in February, global comparable sales fell 0.3%.
Some analysts think McDonald’s golden years are over, and customers’ preferences have parted from what this big fast-food chain has to offer, shifting to healthier diets and more green-bound menus. Furthermore, the overly complicated menu developed by the management the past years did not meet the customers’ expectations, and was one of the reasons for the lower same-store sales. In addition of course the sluggish business environment this industry has been subjected to, with a reduced budget for the customers’ meals and increased competition. Nevertheless, some changes have been announced and the stock seems to be up again. CFO Peter Bensen said the company is trying to optimize its capital structure in order to adapt to cyclical and competitive headwinds, as well as funding greater share buybacks through the acquisition of more debt. Along with the restructuring efforts, new plans to enhance the brand have been announced, with product innovation, capacity/throughput expansion initiatives, store openings and individualized customer-engagement tactics. Overall, despite the under-performance of McDonald’s, this stock actually advanced for the year to date, and has beat the Standard & Poor’s 500 Restaurants Index.
The McDonald’s Gear
McDonald’s counts with a very strong brand intangible asset, with most convenient restaurant locations, a cohesive franchisee system, bargaining clout and advertising scale. As a result the company is positioned in a leading place among peers, with average unit volumes and operating margins above industry averages and one of the widest economic moats in the industry. A mix of structural and intangible competitive advantages has helped McDonald’s build the largest restaurant system in the world.
Through its cohesive franchise system, which operates more than 80% of the chain, the company reduces capital requirements and facilitates EPS growth and ROE expansion. With more free cash flow available, the company expands, increases brand recognition and enhances shareholders return as well. As a result of this well-oiled franchise system, McDonald’s sees an annuitylike stream of rent while remaining less affected by inflation levels than peers.
Expansive efforts continue to be held by the company, with a store opening momentum that remains unruffled. In 2013, McDonald’s spent $3.1 billion toward unit openings and modernization, and expects a capital expenditure target of $2.9 to $3 billion for 2014. Targeting emerging markets such as the Asia-Pacific region, management sees immense potential. Moreover, McDonald’s has been known for its increasing dividend history and regular rewarding of its shareholders. In 2013, the company returned $4.9 billion to shareholders and expects to return 2014 about $5 billion.
Back to the Good Old Days
After suffering disappointing U.S. sales losses, analysts have been wondering what move the company will make in order to regain strength and boost up sales. CFO Peter Bensen explained the chain’s latest strategy: re-focusing on the company’s core. CFO explained “We acknowledged last year that we probably did things a little bit too quickly in terms of the Egg White Delight and then the McWraps and then the Quarter Pounders with the various toppings, and that was a stress to the restaurants.”
McDonald’s business is strong thanks to its burgers, and as so, the company plans to refocus on developing new items in line to what they do best. The Bacon Clubhouse is the new plan, offering beef and chicken burgers topped with special sauce. Basically a Clubhouse Angus with quarter-pound patty, lettuce, tomato and a new bun, this new item is likely to increase sales. The Dollar Menu and More launched in Nov, will include new items like the BBQ Ranch Burger, Buffalo Ranch McChicken and Bacon Cheddar McChicken. High expectations are being put into these new menu innovations, and executives are certainly hoping these items will go down easier than last year’s bold experiments.
Menu innovation options are still to be explored by the company. Beverages for instance remain a sweet spot for McDonald’s, and the company is planning to develop its full potential and adding Fruit Smoothies and Frappes over the next years. Also, the breakfast opportunities are yet to be explored in the Asia/Pacific, Middle East and Africa markets. Moreover, the healthier food consciousness among customers has drove the company to team up with non-profit organization Alliance for a Healthier Generation in Sep 2013, spreading awareness about the healthy food habits as well as including low-fat items such as salads, fruits and vegetables in its value meals. This effort is directed to adapt the company’s food offer to the new market healthier tendency, and consumers’ habits.
Analysts tend to coincide, seeing 2014 as a still less-than-stellar year for McDonald’s in the U.S. The company is indeed directing various efforts towards the development of a more appealing menu for customers, as well as rebuilding its capital structure. Despite the somewhat less optimistic prospects for the company, McDonald’s history has proven to be always a strong bet over the long run, and while sales might be tight these days, they are likely to go up again in the near term. Moreover, McDonald’s has the financial ability to overcome these setbacks, with over $2.7 billion in cash and a strong cash flow, even if it takes some time for sales to regain strength. The company’s venture towards emerging markets is yet to see results, and might give the company the impulse it’s lacking. We should wait and see how these new strategies develop.
Disclosure: Damian Illia holds no position in any stocks mentioned.