MCD remains on the Hedgeye best ideas list as a SHORT.
The company reported disappointing 2Q13 results relative to expectations yesterday, adding merit to our view that management remains hard-pressed to improve MCD’s operational performance. Importantly, we fail to see any indication that these changes will transpire soon.
MCD continues to blame a “challenging environment” as the largest contributor to the company’s issues without any mention of internal operational issues. According to management, all 2013 product launches are working and achieving internal growth targets. Despite this, same-store sales are missing expectations.
Until management acknowledges the internal challenges it faces, disappointment relative to expectations will persist.
MCD’S NEAR-TERM ISSUES:
- Flat to declining markets – from an IEO perspective, the company is seeing contraction in 7 out of 11 of its top markets
- No pricing flexibility – MCD’s price increase was 1.5% at the end of 2Q13, down 120 bps from 2Q12
- Increasing cost pressures across the P&L – management needs to cut G&A in order to hit the numbers
- Increasing competition – Wendy’s, Taco Bell, and others are outperforming McDonald’s
WHAT WE LIKED
- The financial fundamentals of the company remain strong
- The McDonald’s asset base is strong – more than half of its global stores reflect the current contemporary look
WHERE WE SEE RED FLAGS
- The company guided to flat July global same-store sales versus expectations of a 2.9% increase and expects the rest of the year to remain challenging
- Management blamed the “challenging environment” for the decline in same-store sales rather than take responsibility for the poor results
- Germany (MCD’s biggest international market) sales trends are negative and there does not appear to be a viable plan to fix this
- France and other key markets in Europe are cutting labor costs (i.e. realized labor productivity gains), which is a red flag in a declining same-store sales environment
- Cutting G&A in the current environment is also a sign of weakness and a major red flag – lower incentive compensation and efficiency gains are unsustainable
- Lower unit growth in China means that I lost a bet to Tim Jerzyk, formerly of YUM
Howard Penney
Managing Director