MCD: TIME & MOTION

For the past year, we have been harping on our “Espresso-Based Conspiracy Theory” as one of the reasons why McDonald’s is struggling to grow its top line.  The evidence supporting this assertion continues to pile up.


In short, we believe the McCafe strategy creates additional complexity in the back of the house and diverts resources away from the core food business.  We’ve always viewed McDonald’s as a food first destination and whenever management shifts their focus away from food and to beverages, the core business suffers.  To that extent, we contend that the early success of the beverage strategy (cold beverages) masked a decline in the core business (selling burgers and fries).

 

At the most recent analyst meeting and earnings call, management finally began to “come clean” with some of the issues that are impacting sales trends.  None of the issues the company addressed, however, included McCafe.  In fact, part of their 2014 strategy includes increased marketing resources to “go after the coffee consumer in 2014.”

 

On the 4Q13 earnings call, Chief Operating Officer Tim Fenton admitted that the never-ending LTOs and menu changes in 2013 overcomplicated operations.  The menu changes in 2013 included:

  1. Mighty Wings
  2. Premium McWraps
  3. Steak & Egg Burrito
  4. Fish McBites
  5. Steak Breakfast Sandwiches
  6. New Quarter Pounders
  7. Grilled Onion Cheddar Burger
  8. Hot’n Spicy McChicken
  9. The Dollar Menu & More (with five new burgers)

During the analyst meeting a couple of months ago, Don Thompson said: “We stumbled a bit last year with too many new products, too fast and we created a lot of complexity.”  This may be true, but we contend that the issues McDonald’s faces did not start in 2013.  These issues really date back to 2009/2010, when we saw the national launch of McCafe and an accelerating number of menu introductions.

 

Later in the note, we use a chart from Burger Business, along with management’s comments from the 4Q13 earnings call, to put our thesis in perspective.

 

By way of background, part of the 2003/2004 “Plan to Win” strategy included a Time & Motion analysis of the restaurants’ back of house operations.  With this study, management had determined that employees’ movement in the kitchen had become inefficient.  Management’s desire to fix this was a key driver in simplifying the menu and streamlining operations.

 

In 2014, management is now once again talking about the Time & Motion of employees in the back of the house.  However, this time management does not appear to be a taking a holistic approach to fixing these issues.  Rather, these moves strike us as more geared to specific menu items.  To illustrate our point, we have reproduced a chart from Burger Business looking at the evolution (bloating) of the McDonald’s menu since 2004.

 

As you can see in the chart below, the total number of items on McDonald’s menu increased by 75% from 2004 to 2014.  This means an incremental 51 items have been added to the menu over that period, making the current day menu very difficult for crews to execute.

 

More importantly, there are two sections that account for the bulk of the menu proliferation.  Not only are the number of Burgers, Sandwiches, Wraps up by 60%, but McDonald’s also created a whole new beverage category called McCafe (espresso drinks added in 2009; smoothies and frappes added in 2010).

 

MCD: TIME & MOTION - 1 30 2014 10 10 14 AM

 

 

Knowing how important Time & Motion is to the performance of McDonald’s restaurants, we continue to believe that McCafe has played a critical role in the slowing sales trends at their restaurants.  This is an issue that management continues to ignore and could very well exacerbate!

 

To their credit, management has addressed part of the menu proliferation with the roll out of its high density kitchen tables.  As management said on the 4Q13 earnings call, “These new high density kitchen prep tables are designed to deliver enhance service capabilities and menu choice to our customers.”  We believe these high density tables should address Time & Motion issues associated with burgers, sandwiches, and wraps – to an extent.  Management also supported this thought: “On the capacity, any time during our peak hours, if I can keep place in place and not have their feet moving to restock or to get something else or have crossover,” they, theoretically, will be able to improve the performance of their stores.

 

While this may be a step in the right direction in an attempt to better execute the current menu, this will also allow for additional customization.  While they may need this additional customization to remain competitive in the market place, it could mitigate some of the benefits of the high density tables.

 

In addition, management has failed to address the proliferation of beverages and the impact of the McCafe strategy.  Is it possible to add two new pieces of equipment (needed to make McCafe beverages) and not create additional Time & Motion inefficiencies?  We don’t think so, but management appears unwilling—at least at this point—to acknowledge this.

 

So how does this end?

 

The high density kitchens will be rolled out to the entire system by the end of 2Q14.  Therefore, McDonald’s should begin to see better sales trends by July 2014.  If, however, this doesn’t happen and weakness persists into 2H14 (meaning high density kitchen tables are not the panacea for sluggish sales trends), the focus of analysts and investors will shift to other issues the company could be facing.  If and when this time comes, we’d expect management to be more upfront about the issues surrounding the McCafe strategy. 

 

Only time will tell.

 

If management’s denials persist, we believe the stock will continue to underperform and may prompt Bill Ackman to dust off the old McDonald’s slide deck and step in to push for more changes at the company.

 

 

Howard Penney

Managing Director

 


Did the US Economy Just “Collapse”? "Worst Personal Spending Since 2009"?

This is a brief note written by Hedgeye U.S. Macro analyst Christian Drake on 4/28 dispelling media reporting that “US GDP collapses to 0.7%, the lowest number in three years with the worst personal spending since 2009.”

read more

7 Tweets Summing Up What You Need to Know About Today's GDP Report

"There's a tremendous opportunity to educate people in our profession on how GDP is stated and projected," Hedgeye CEO Keith McCullough wrote today. Here's everything you need to know about today's GDP report.

read more

Cartoon of the Day: Crash Test Bear

In the past six months, U.S. stock indices are up between +12% and +18%.

read more

GOLD: A Deep Dive on What’s Next with a Top Commodities Strategist

“If you saved in gold over the past 20 to 25 years rather than any currency anywhere in the world, gold has outperformed all these currencies,” says Stefan Wieler, Vice President of Goldmoney in this edition of Real Conversations.

read more

Exact Sciences Up +24% This Week... What's Next? | $EXAS

We remain long Exact Sciences in the Hedgeye Healthcare Position Monitor.

read more

Inside the Atlanta Fed's Flawed GDP Tracker

"The Atlanta Fed’s GDPNowcast model, while useful at amalgamating investor consensus on one singular GDP estimate for any given quarter, is certainly not the end-all-be-all of forecasting U.S. GDP," writes Hedgeye Senior Macro analyst Darius Dale.

read more

Cartoon of the Day: Acrophobia

"Most people who are making a ton of money right now are focused on growth companies seeing accelerations," Hedgeye CEO Keith McCullough wrote in today's Early Look. "That’s what happens in Quad 1."

read more

People's Bank of China Spins China’s Bad-Loan Data

PBoC Deputy Governor Yi says China's non-performing loan problem has “pretty much stabilized." "Yi is spinning. China’s bad-debt problem remains serious," write Benn Steil and Emma Smith, Council on Foreign Relations.

read more

UnderArmour: 'I Am Much More Bearish Than I Was 3 Hours Ago'

“The consumer has a short memory.” Yes, Plank actually said this," writes Hedgeye Retail analyst Brian McGough. "Last time I heard such arrogance was Ron Johnson."

read more

Buffalo Wild Wings: Complacency & Lack of Leadership (by Howard Penney)

"Buffalo Wild Wings has been plagued by complacency and a continued lack of adequate leadership," writes Hedgeye Restaurants analyst Howard Penney.

read more

Todd Jordan on Las Vegas Sands Earnings

"The quarter actually beat lowered expectations. Overall, the mass segment performed well although base mass lagging is a concern," writes Hedgeye Gaming, Lodging & Leisure analyst Todd Jordan on Las Vegas Sands.

read more

An Update on Defense Spending by Lt. Gen Emo Gardner

"Congress' FY17 omnibus appropriation will fully fund the Pentagon's original budget request plus $15B of its $30B supplemental request," writes Hedgeye Potomac Defense Policy analyst Lt. Gen Emerson "Emo" Gardner USMC Ret.

read more