McDonald’s (MCD, Financial) size, which has been a huge advantage for the company over the years, has suddenly became a liability and the company has been struggling to turn around its growth story. Though comparable store sales returned to positive territory since the second half of last year, revenue growth is still stagnant, with the fast food restaurant reporting a 2% decline in revenues in the first six months of the current fiscal.
Current Performance
After seeing its comparable store sales stagnate in its home country, McDonald's decided last year to reduce its exposure by refranchising its stores. The company announced in May 2015 that it will sell 3,500 of its company-owned stores worldwide to franchisees by 2018, in an effort to cut costs and shore up profits. While McDonald’s pursues its refranchising plan to reduce risk and shore up the bottomline, the company also announced an all-day breakfast plan to stem the sales slide and shake up its own management team.
“The new chief executive at McDonald’s Corp. plans to sell more restaurants to franchisees and restructure international operations to cut $300 million in annual costs and create a more nimble business.” - WSJ
In the first six months of the year, worldwide comparable store sales increased by 4.6% and U.S. store sales increased by 3.5%, while the high growth segment posted a 2.6% increase. It is clear that stores have performed a lot better this year compared to the first six months of 2015. As the company sells its company owned stores to franchisees, it has to let go of the sales numbers and be happy with the fees that franchisees pay, which generally boosts margin numbers.
For any restaurant company, whether it is entirely company-owned or entirely franchised, the overall revenue growth can be directly attributed to two factors:
Same store sales - how many extra diners walked into the restaurant this period compared to the same period last year, and how well they accept price increases
Net unit expansion - the difference between new store openings and store closures
What to Expect from McDonald’s
The elevated awareness around health and fitness has made the current generation a little more conscious about what they eat. It is not without reason that Chipotle (CMG, Financial) was able to grow its stores at such speed in the last ten years and increase revenues in the process. Had it not been for the E. coli fiasco, the burrito maker was set to run over all the burger makers for good. Burgers, for some reason, have always had the junk food label stuck to them, but the glory days of most burger joints are all but over. I say this because there are still millions of people around the world that prefer “unhealthy” foods over healthier alternatives.
But for McDonald’s, it means things will be stable at best and the company needs to constantly revamp its product lines to stay relevant.
On the unit growth front, McDonald’s is already the largest restaurant chain in the world, with 14,000 in the US, 5,000 in Asia and Europe, and a grand total of 36,000. That also means it won’t be easy to expand as aggressively as in the past ten years.
Although I believe McDonald’s will remain a cash machine for a very long time, stability is the best it can hope for considering its scale and size. Moreover, as they continue to push their refranchising agenda, they can only expect sales growth to slow down in the future.
Disclosure: I have no positions in any of the stocks mentioned above and no intention to initiate a position in the next 72 hours.
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