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Takeaway: You be the judge.
This note was originally published September 25, 2013 at 11:17 in Restaurants
Editor's note: This is a complimentary research report from Hedgeye Managing Director and Restaurants Sector Head Howard Penney. For more information on how you can sign up to receive our research please click here.
Clients often remind us that we’ve had a great call on MCD this year, but also prod us not to get carried away with our bearish bias. Admittedly, this is not an easy feat – but, as the facts change, so will our call. Our intention is always to remain flexible in our coverage.
That being said, our bearish bias has not changed. Below we highlight four recent events and their potential implications.
- The stock outperformed the S&P 500 over the past month
- The current Mighty Wings promotion
- Changes in the Eurozone
- Personnel changes in the U.S.
Stock Price Performance – MCD is up +2.8% over the past month, outperforming the S&P 500 and its quick-service peer group by 80 bps and 200 bps, respectively. Given that the stock had underperformed the S&P 500 by -20.9% YTD, we knew the slightest whiff of good news would push the stock higher. So where is the good news coming from?
Mighty Wings – MCD hasn’t generated as much buzz around a limited-time offer (LTO) since the McRib promotion. But, at the end of the day, it is just a LTO. The recent buzz might create a month or so of stronger sales trends, but we don’t view this promotion as a game changer for the company. Selling chicken wings may temporarily boost sales, but, in the long run, we fear that it will end up inflicting more harm than good. Asking the currently disgruntled franchisee community to prepare yet another product, with a slower than normal preparation time, will only add to the service issues the company is already experiencing. In our view, this is likely to lead to further deterioration of the MCD brand.
Changes in the Eurozone – MCD has been trading better since the release of August comps on September 10th. Global trends in August were stronger due in large part to better than expected results in Europe. The company reported Europe same-store sales growth of +3.3%, on top of +3.1% growth a year ago, as the UK, Russia, and France were strong. Several of the MACRO indicators we monitor in Europe continue to show improvement in the region, specifically in Germany, MCD’s most important European region. Today, the forward-looking German Consumer Confidence Indicator from the GfK Survey rose to 7.1 for October, surpassing consensus expectations. GfK notes that, “despite a fall in income expectations, German consumers are almost euphoric when it comes to their propensity to consume.” Investors also got some good news from Italy, another market that has given MCD considerable headaches in the past. Today, Italy’s Consumer Confidence Index jumped to 101.1, its highest level since June 2011.
Personnel Changes in the U.S. – Yesterday we learned that MCD’s Neil Golden plans to retire early next year. Given the importance of MCD’s marketing message, it is clear that the company does not have its act together, particularly in its most important region, the U.S. Despite the recent limited-time offer of Mighty Wings, McDonald’s continues to struggle in the region.
The stock is having a strong month and Europe is looking stronger, on the margin, for the company. However, the U.S. continues to struggle and we believe it will be a while before the company returns to high-single digit EPS growth.
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After posting the best Japanese auto sales number in 14 months, the Yen continued its latest run higher and is finally signaling immediate-term TRADE overbought vs US Dollar.
No. The Nikkei definitely does not like #StrongYen. It closed down -2.1%, leading the losers in Asia overnight. Japanese stocks are oversold right now.
Yes. It's a good spot to buy.
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MCD remains on the Hedgeye Best Ideas list as a short.
To be clear, we believe MCD has a secular top line issue and not a cyclical one. That said, we don’t believe management is willing to acknowledge this. So far in 2013, the new product pipeline has failed to stimulate incremental customer traffic and new products, such as Mighty Wings, seem like a desperate attempt to hide from reality.
We posted a note a couple of weeks ago titled, “MCD: A Pending Mighty Disaster,” in which we stated that MCD’s decision to sell wings this fall could be disastrous for the company. Given current trends, we have no reason to back off this negative bias.
We have three main issues with the current MCD menu strategy:
- Mighty Wings will not enhance the McDonald’s brand (Premium Wraps have not helped either)!
- Both new products (Mighty Wings and Premium Wraps) have slow service times.
- Adding new products to an already complex menu is the wrong direction for the company to go.
We also have two main issues with the Mighty Wings promotion:
Mighty Wings Are Too Expensive
For the smallest portion, you are paying a dollar per mighty wing.
McDonald’s Mighty Wings are available in three portion sizes. There is a 3-piece for $2.99, a 5-piece for $4.79 and a 10-piece for $8.99. Across the pricing spectrum, this is equivalent to paying $0.99, $0.96, and $0.90 per wing, respectively.
Inconsistent Product From McDonald's
We are hearing that frequent visitors of McDonald’s are not used to the bone-in chicken wings product. While bone-in chicken wings are standard fast food options for restaurants that specialize in fried chicken – for example, KFC and Popeyes – it does not seem to fit well with the rest of McDonald’s products.
This whole situation is all too reminiscent of the period from 1, when we witnessed the sad decline of a mismanaged McDonald’s brand. During that time, the company was focused on unit growth and cost reduction rather than driving high margin, top line sales.
As the image of the brand began deteriorating, management failed to invest in the brand and customer experience. Rather, they turned to monthly promotional tactics in order to drive short-term sales at the expense of brand equity and margins. This strategy did not end well for either the company or investors and we’d be surprised if this time was any different.
We continue to believe there is a disconnect between investors’ expectations and the company’s fundamentals. As long as this remains the case, we are looking for more underperformance versus both peer consumer and S&P 500 benchmarks.
Mario Draghi and the ECB’s governing council voted today to keep rates unchanged, although a cut was suggested by some members.
Last month’s dramatic pivot to a dovish monetary tone that interest rates should remain “at present OR lower levels for an extended period of time” was reiterated again today in remarks that monetary policy will remain accommodative for “as long as is necessary”. Draghi described an economy that is “weak, fragile, and uneven” and left the prospect of issuing another LTRO on the table. We expect that given the continued clog in the credit channel, a liquidity package could be released into year-end (see chart below).
Interestingly, and despite the dovish commentary, the EUR/USD rose following the announcement, which we think is reflective of the impact of Bernanke talking down U.S. growth prospects (and the USD), as well as the Eurozone economy showing improvement on the margin.
As central bankers struggle to guide expectations (hint Fed’s no-taper decision and the ECB’s and BOE’s forward guidance) we wouldn’t be surprised to see Draghi keep his cards tight on when he may issue liquidity measures or cut rates, and continue to drag his feet on any policy action until more data confirms his team’s outlook.
As it relates to the Eurozone, our call remains that we expect Europe’s economy to gradually improve off low levels (we’re UK and German equity bulls) and bullish on the EUR/USD, which is in a bullish breakout above its TRADE, TREND, and TAIL levels (see chart below).
Draghi highlights from the Press Conference:
- Somewhat weaker growth in the beginning of Q3, but still expects a gradual recovery
- The recovery is “weak, fragile, and uneven” and starting from very low levels
- Unemployment, especially youth, needs to be reduced from very high levels
- Credit dynamics remain subdued with flows “still weak, very weak”
- On broader developments of liquidity: ECB is ready to use all available instruments, including LTRO
- Inflation continues to be firmly anchored, on the very low side of the 2% target (at 1.1%), but the baseline scenario has been underpinned
- Progress is being made on political reforms: greatest pressure should come from the inside; don’t need to be pressed by markets
- On political instability (Italy and the rise of anti-Euro parties in Germany and Austria): while instability hampers hopes for a recovery, it doesn’t hurt the foundations of the Eurozone as it used to do a few years ago -- that suggests that the Eurozone and Euro is more stable
Takeaway: A quick look at stories on our radar screen.
Tom Tobin – Healthcare
Web traffic, glitches slow Obamacare exchanges launch (via Reuters)
Keith McCullough – CEO
Japan Auto Sales Climb Most in 14 Months (Bloomberg)
Letta Wins Confidence Vote After Berlusconi Support (via WSJ)
Israel PM calls Iran leader 'wolf in sheep's clothing' (via BBC)
Pirates' First postseason Win Since 1992 (via ESPN)
Jonathan Casteleyn – Financials
Gundlach’s Fund Had Its Biggest Redemptions in September (via Bloomberg)
Fed Said to Review Commodities at Goldman, Morgan Stanley (Bloomberg)
Howard Penney – Restaurants
McDonald’s Stores Trying Loyalty Program to Attract Millenials (via Bloomberg)
Brian McGough – Retail
Lululemon’s sheer yoga pants lawsuit gets lead plaintiff (via NY Post)
NBA Standout Stephen Curry Joins Under Armour Basketball Roster (via Sports One Source)
Jacobs Exits Vuitton To Focus On IPO (via WWD)
Kevin Kaiser - Energy
Kinder Morgan Detailed Analysis (via Scribd)
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