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McDonald's Needs a Robust Reinvention Plan for Growth

May 09, 2014 | About:
Riddhi Kharkia

Riddhi Kharkia

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In my previous article on Starbucks (SBUX), I mentioned the significance of the comparable store sales metric for retail stores and while Starbucks did a great job at securing high comps, another equally famous chain failed to report a positive growth on this parameter. I am talking about the famous fast food chain McDonald’s (MCD), which reported its first quarter results a few days back. The results were not only disappointing but also gave an indication of an expected tough time.

Results for First Quarter 

Though the revenue expanded marginally in the first quarter ended March 31, 2014, earnings per share for the quarter declined primarily due to the impact of prior-year income tax benefits. First quarter results included a global comparable sales increase of 0.5 percent, reflecting higher average checks, as well as negative guest traffic in the U.S., Asia/Pacific and Middle East and Africa (APMEA). Consolidated revenue increased by 1 percent (3 percent in constant currencies), while consolidated operating income decreased by 1 percent (1 percent increase in constant currencies). Diluted earnings per share of $1.21 reflected a decrease of 4 percent (2 percent in constant currencies). In the U.S., comparable sales decreased 1.7 percent in the first quarter, and operating income declined 3 percent. Top-line results for the quarter reflected negative comparable guest traffic amid challenging industry dynamics and severe winter weather.

Areas of growth

One of the focus areas spelt out by the management in the earnings call related to optimization of menus so as to increase the returning rate of its customers. Again referring to my previous article, one of the reasons I mentioned for the sturdy growth of Starbucks is the freshness in product portfolio that the company has been able to sustain over the years. Also, novel ventures like the Teavana business, and Fizzio cold beverage will only contribute to the massive size of the product portfolio. Hence, McDonald’s needs to focus clearly on building a diverse and sustainable product portfolio in order to increase the comparable store sales. This what the CEO had to say in the earnings call:

Our global growth priorities are focused on ensuring that we remain relevant and appealing, so that more customers will visit us more often. We’re focused on optimizing our menu so that we offer our customers food and drinks that have strong appeal, on modernizing the customer experience in our restaurants, so that that experience for each customer is more memorable; and on broadening accessibility so that we deliver on unparalleled convenience. The key to our growth lies in our ability to place the customer at the center of everything that we do.”

Mission China

Besides the abovementioned factors for growth, investors should also watch out for the company’s future plans in relation to one of the most significant markets in the Asian region, i.e China. While the U.S. is a saturated market for McDonald's, China's middle class is expanding pretty quickly. A report published by McKinsey & Co. in 2012 calculated that the number of people in China that earned between $17,000 and $35,000 would grow from only 6% of the population in 2010, to more than 50% of China's populace by 2020. Hence, the Chinese markets represent a highly lucrative opportunity for the company in the future. The visible negative traffic in the U.S. has necessitated the need to look for growth in hitherto untested areas including China and India. In fact, the comparable store sales grew by 80 basis points in the APMEA region with China recording a spike of 6.6% for the quarter.

The company has big plans in store for China as they are set to open about 300 new restaurants this year. McDonald’s is continuing to accelerate its franchising efforts; about 15% of restaurants in China are franchised as of the end of the quarter and it is on track to achieve the mid-term target of 20% to 25% franchise restaurants.

Shareholder Friendly

While the company may be risky in the future, it has been a generous giver in the present. The management did not fail in highlighting company’s commitment to returning all of the free cash flow after meeting expenses to shareholders through dividends and share repurchases. In the first quarter, it returned $1.2 billion to shareholders through dividends and share repurchases combined. This is not a hard fact to digest keeping in mind McDonald’s past history as it has returned an average of over $5 billion per year to shareholders since 2009.

Final Words

There is no doubt about the fact that McDonald’s has to initiate some measurable changes in its operations in the future. Also, the past results of the company have not been quite attractive, especially the decline in comps in the U.S. As such, it is advisable to stay away from McDonald’s till there are constructive signs of improvement in the mentioned focus areas.

About the author:

Riddhi Kharkia
A practicing Chartered Accountant based out of India. I have keen interest in analyzing tech stocks that are driven by value.

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