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News items and notable price moves over the last twenty-four hours

  • MCD added to the US focus list at Credit Suisse Rating is outperform - target is $87.
  • MCD McDonald's upgraded to outperform from sector perform at RBC Capital
  • SBUX is taking its mobile payments plan nationwide. The company started testing mobile payments in September 2009 and now it is expanding the program to 6,800 stores across the country and soon onto other devices.
  • SBUX rolled out new beverage size.  The “Trenta” size will contain 31 ounces and cost about 50 cents more than the 20-ounce Venti size, according to Starbucks.
  • SBUX employees at the Astor Place store in NYC have announced that they have formed a union.  The disgruntled employees cited a need to stand up for themselves as, “Starbucks will not act in our best interests”.
  • YUM to sell Long John Silver's and A&W restaurants
  • BAGL was raised to "Buy" from "Hold" at Stifel Nicolaus  - target is $18.00 per share
  • Despite disappointing casual dining numbers from Malcolm Knapp, casual dining companies traded declined modestly yesterday.



Howard Penney

Managing Director


All great truths begin as blasphemies - George Bernard Shaw


This “Black Book” outlines the current state of McDonald’s operations with a particular focus on its U.S. business. The company’s shares have performed tremendously since the implementation of their “Plan to Win” initiative in 2004 and competitors have found it hard to match McDonald’s performance.  Furthermore, the company is healthy and generates impressive levels of cash for shareholders.  All good things come to an end, however, and I see significant hurdles for the U.S. business in 2011 that present an auspicious opportunity to be a seller of this stock. 


When McDonald’s was first embarking on its highly successful “Plan to Win,” the company set out on a comprehensive program designed to “optimize and simplify operations.”  This program included offering fewer sizes of drinks and fries, fewer Extra Value meals, more simplified pricing, and streamlined merchandising supported by intensive hospitality training of employees. 


For most of McDonald’s history, growth was driven by one thing: unit growth.  Until the late 1990s, that strategy worked.  When the company reached a saturation point, sustaining unit growth resulted in cannibalization, which caused same-store sales growth and margins to deteriorate steadily until the “Plan to Win” was announced.  As Jim Skinner once put it, "We had lost our focus. We had taken our eyes off the fries."


Companies churn out new “plans” ad nauseum, but in the case of McDonald’s in 2004, there was a clear need for management action.  In fact, operations had become so complicated that the average crew served one less customer every two hours between 2000 and 2004, which cost the company 135 basis points in company-operated margins.  Over the next six years, the company’s commitment to their “Plan to Win” yielded 600 basis points of restaurant-level margin expansion.  Accordingly, the stock price appreciated by ~160% by the end of 2010, or by 175% at its more recent December 2010 peak, from the implementation of the “Plan to Win” in November of 2004. 


Six years later, however, it appears that the lessons of the late 1990’s and early 2000’s have gradually been forgotten as a focus on driving same-store sales took precedence over all else.  The relentless focus on driving the top line has required the franchise system to invest significant capital in facilities and new equipment.  Further, from an operational standpoint, this approach has resulted in a burgeoning menu as item after item is rolled out, thereby complicating back-of-the-house operations and gradually offsetting much of the progress made in that regard by the “Plan-to-Win”.


As a specific example, McDonald’s rolled out the Southern-style chicken sandwich in 2008 with much fanfare and the goal of taking share from Chic-fil-A.  The rest is history; the product failed to deliver.  This episode smacks of the McDonald’s of old: launch new products, withdraw marketing support when the product doesn’t deliver but keep them on the menu.  The clear result is a complication of the menu and an inefficient back-of-house process. 


The “Plan-to-Win” mantra has always been "better, not just bigger.”  Instead of building more restaurants, McDonald's increased profitability by squeezing more from its existing store base and from its franchisees.  As a side point, the company loves to talk about the increased “cash flow” of its franchise base, but the more salient metric from a franchisee’s perspective is the “net” cash flow after servicing debt incurred to finance remodels and initiatives.


Over the past three years, however, the mantra has seemingly become “beverages, not burgers.”  As the company has shifted its focus away from its core business, that segment of the business has inevitably suffered.  Over time, the company has shifted so much time and effort (including marketing dollars) away from its core menu that it is losing ground to peer QSR burger concepts and also gourmet/niche burger players.  If we assume that the core business of MCD’s U.S. business is declining, then the emergence and growth of new operators in the burger space is likely impacting MCD’s U.S. business.  Bobby Flay, Five Guys, Shake Shack, Burger Bar, the Counter Burger, and others have gained popularity over the last few years. 


I believe McDonald’s needs to get back to what got it to where it is: its core business.  In the Wall Street Journal this week, there was an insightful article on McDonald’s Japan which is focusing on the core business.  Considering the reputation Japan has as a particularly healthy society, I was interested to read the following, ‘Yasutsuru Mori, a svelte 74 year-old patron, wolfed down a Texas 2 Burger this weekend.  "I love hamburgers.  I eat every new hamburger that comes out in Japan, but I especially love McDonald's burgers," he said.  "McDonald's keeps to the fundamental American hamburger profile: ketchup, mustard and beef.’  Clearly, this is just one person, but I believe that McDonald’s needs to refocus on its core business here in the U.S. also.


Notwithstanding my concerns, I would be remiss not to acknowledge the achievements of the company in what was a truly spectacular turnaround from 2004.  By keeping their “eyes on the fries”, MCD’s management team created an example of operational focus and discipline for operators in both the quick service and casual dining categories.  The “Plan-to-Win” forced management to rethink every element of its business, from product development and marketing to restaurant design and technology.  In the process, McDonald's, which had seemed out of touch with consumers just six years prior, had realigned itself with contemporary tastes. 


To see the balance of the McDonald's "Black Book" please reach out via e-mail or phone.  My contact details are below.


MCD - THE BLACK BOOK - mcd black book cover


Howard Penney

Managing Director

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The Macau Metro Monitor, January 19, 2011



The Land, Public Works and Transport Bureau (DSSOPT) has ordered Caesars Golf Macau, owned by Caesars Entertainment, to cease its unlicensed construction of a private road to join Estrada do Istmo.  The manager of Caesars Golf Macau said the company will restore the area according to the Government’s requirements and Macau laws.  Chief of the DSSOPT department of environmental pollution control, Ip Kuong Lam, said the site was originally a domestic waste landfill between 1988 and 1992, and right now a lot of the garbage had decomposed leaving mostly plastic materials.


The golf course will be punished based on the water supply and drainage regulations.

CHINA DEC CPI UP 4.6%, 2010 GDP UP 10.3% Economic Times

According to unnamed sources, China's CPI gained 4.6% in December, slowing from 5.1% in November. China GDP grew 10.3% in 2010.  The median forecast of economists polled by Reuters was for December's CPI to rise 4.4% and GDP to increase 10.2%.

Chirp, or Be Chirped

This note was originally published at 8am on January 14, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“The fact that we are today to debate raising America’s debt limit is a sign of leadership failure.”

-Senator Barack Obama, March 2006


Our CEO Keith McCullough has been out most of this week recovering from a surgery to reattach his Achilles tendon.  I’ve known Keith for upwards of fifteen years, including three years as college hockey players, so I can rightly say that I’ve seen the man in a few precarious situations, but never did I think he would injure himself on the squash courts.  So when it comes to risk management for the aging college athlete, leave the squash to those that grew up playing it at prep schools is my advice on a go-forward basis.


With Keith out, I’ve had to live a week in his shoes.  I’m not prone to giving the proverbial tire pump, but, candidly, it’s not easy to write a morning strategy note and prep for a morning call every morning starting at 5 a.m.  As it relates to President Obama and the quote above, I think he is now realizing what it’s like to live in another man’s shoes, as well.   (Life as President is much different than as a member of Congress it seems.)


Members of Congress in Washington basically have free rein to chirp.  While Presidents can chirp as well, they also have to make decisions.  Obama’s quote (chirp) above was prescient back in 2006, but in the coming weeks he will have to push to get the debt ceiling raised because, as President, he needs to keep the country running.  The advisors hired to chirp on his behalf have been out in full force making sure he has the political cover to get this done.


Specifically, White House economic advisors Austan Goolsbee recently had this to say about the debt ceiling:


"This is not a game. You know, the debt ceiling is not something to toy with. … If we hit the debt ceiling, that's essentially defaulting on our obligations, which is totally unprecedented in American history. The impact on the economy would be catastrophic. I mean, that would be a worse financial economic crisis than anything we saw in 2008."


Now, if that’s not chirpy, I don’t know what is.


Freshman Senator Rand Paul was not to be outdone though, and chirped back his own proposal:


“I can't imagine voting to raise the debt ceiling unless we're going to change our ways in Washington. I am proposing that we link to raising the debt ceiling — that we link a balanced budget rule, an ironclad rule that they can't evade.


We have to change the rules and we have to say to Washington, Balance the budget. You have to do it by law.  And then I'll vote to raise the debt ceiling.  But only if we have an ironclad balanced budget rule that we attach to the debt ceiling.”


Ironically, the best assessment of the debt and debt situation was probably Senator Obama back in 2006.  The fact is that we are in this fiscal situation today because of failed leadership.  This is failed leadership that has transcended administrations and political parties. It is because the United States has created long term obligations in the way of social security and healthcare that we can’t fulfill, and administrations have overspent on discretionary items when times were good.  (In fact, our friend Karl Rove even acknowledged to us that the one regret he had was that the Bush administration didn’t do a better job on discretionary spending.)


In the coming weeks, the debate over the debt ceiling will increase in velocity and volume.  The fiscal conservatives, particularly those who were swept in with the Tea Party in the most recent midterm, will be on the soap box and will be chirping like never before.  Unfortunately, even Goolsbee’s language and delivery is somewhat inflammatory, and as a nation, we really have no choice, but to increase the limit on the debt ceiling.


In the coming months, there are three key catalysts that will take the debate over the debt and deficit to a heightened level, these are:


1)      Late January - Congressional Budget Office deficit projections will have to be raised dramatically for the next few years.  We’ve highlighted their projections in the Chart of the Day, and, simply put, the numbers are too low for what we’ve already seen in Q1 of fiscal 2011.


2)      Mid February - President Obama’s draft budget proposal will be submitted in early February.  This proposal will be more heavily scrutinized than any budget in recent memory and since so few of the line items can be played with in the short term, they’ll surely not satisfy the fiscal conservatives.


3)      Early March - Finally, the vote on the debt ceiling will occur sometime before March 4th.  This is when the debate will reach its highest pitch even though the outcome is already known, which is the ceiling must go higher.


We believe the outcome of all of this could be, American Sacrifice. This is the idea that this debate actually drives our politicians to implement meaningful initiatives that will begin to reverse the fiscal predicament we are facing.  If we do start to see fiscal improvement, or at least positive discussions in that direction, it will be bullish for the U.S. dollar.


That said, as it relates to Washington, one never knows and productive legislation will actually require these politicians to set aside their “chirp, or be chirped” politicking, and help move the country forward.


Yours in risk management,

Daryl G. Jones


Chirp, or Be Chirped - Chirp

CHART OF THE DAY: Government Credibility


CHART OF THE DAY: Government Credibility -  chart of the day

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