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McDonald's: Millennials Aren't the Problem

This note was originally published October 23, 2014 at 07:04 in Restaurants

 

MCD is a financially healthy company, but its business model is broken and in desperate needing of a fixing.  Alas, merely changing the service style is not the answer and could, in fact, create additional friction within the franchise system. 

 

More importantly, McDonald’s does not have a Millennial problem, as it hinted on Tuesday’s earnings call.  The real issue is the food it is serving.  Food that is, for the most part, inferior to that of its competitors.  It simply doesn’t resonate with consumers, and it will take much more than a “myth buster” for this to change. 

 

McDonald’s recent earnings call lacked clarity.  To their credit, management is trying to stem the sales decline and even conveyed a sense of urgency in doing so.  The issue, however, is that management can’t properly communicate what the actual problem is, rendering their solution haphazard.  But, perhaps more concerning is the reactionary nature of these initiatives.

 

Both management and analysts alike were focused on the fact that Millennials are skipping out on McDonald’s to go to chains such as Chipotle.  Last night, Sonic reported a +4.6% same-store sales increase and, interestingly enough, didn’t mention the word Millennials once on the earnings call. 

 

Wendy’s, another brand that has been resonating lately, isn’t particularly focused on Millennials either.  Why then is it necessary for McDonald’s to pin its troubles on Millennials?  The company’s issues run far deeper than this and it will take some serious soul-searching for it to regain the momentum it once had.

 

The message sent to the McDonald’s franchise system yesterday was loud and clear: we will do what it takes to grow sales and you better get on board.  The current plan, as it stands, will be very expensive for franchisees and will not impact sales until sometime in 2016.  It also fails to address the issues that have been plaguing the system for the better part of the past three years.

 

McDonald’s CEO, Don Thompson, said on the call:

 

“The reality is we haven’t been changing at the same rate as our customers’ eating out expectations, or more specifically, their expectations of us at McDonald’s.  So we’re changing, and we’re changing aggressively as we refocus on building the business for the McDonald’s system and four our shareholders.”

 

Listen, we know why he said this – everyone wants to hear it.  But what does he really mean?

 

While we are delighted to see management recognizes the need for change, we find it slightly disingenuous that it has taken them this long to admit it.  Same-store sales have been declining for two straight years, which it why we find it odd that management has finally realized that customers wanted the ability to personalize their meals.  McDonald’s installed the made-for-you system 10 years ago for this very reason – customization. 

 

Also of note is the company’s commitment to having leading edge point-of-sale systems, mobile technology, and free Wi-Fi.  This isn’t a competitive advantage, in our view.  Nowadays, it’s more like… normal.  We agree that integrating Apple Pay across 14,000 U.S. restaurants is a good move, although we don’t know the impact it will have on drive-thru speed of service. 

 

The company has already tested a multiple order point strategy and self-order kiosks which, to their credit, have limited some of the front-of-counter confusion, but it is far from being the panacea. 

 

If you recall, the made-for-you rollout was initially a disaster that took several years to get right.  It makes sense, therefore, to assume that the cost and the installation of new technology will be a disrupting force within the McDonald’s system.

 

Yesterday, management officially announced they are accelerating the development of a new service style called, “Create Your Taste,” which combines a custom premium burger platform with new service enhancements.  According to Thompson, this new service experience will ultimately create the “McDonald’s Experience of the Future.”  However, we view these initiatives as defensive and fail to see how they will meaningfully separate McDonald’s from the competition.

 

The company plans to fully activate this new experience in three markets a little less than a year from now, and will roll it out to additional markets as permits.  In Australia, plans are already in place to scale this experience across the entire country by next year.

 

It will take years for the company to rework the system to this new service style and it will only impact approximately 40% of the business.  The other 60% of the business is generated by the drive-thru, where customization is not an option.

 

Noticeably absent from the call was an in-depth discussion revolving around enhancing the food and the menu.  In fact, it seems as though the current strategy is to simply tell consumers how good the food is at McDonald’s.  There appears to be no plan to actually change, or upgrade, the food to offer the quality consumers are seeking.  Merely, engaging in dialogue with consumers is unlikely to alter the secular decline in sales the company is experiencing.

 

Management has plans to simplify the menu next January, which we applaud, but to what extent is largely unknown.  According to them, the goal is to “highlight customers’ favorites and to make the experience faster and easier for our customers and our crew.”  But, by summer 2014, they plan to introduce different new tastes on a regional basis, essentially complicating things all over again. 

 

There are many issues with McDonald’s, which makes it odd that they would try to pin it on its disconnect with Millennials.  While it’s a convenient excuse, the reality is they don’t have a Millennial problem.  They have a cultural problem.  Consumers are looking for high quality food served fast, fresh, and in a clean and enjoyable environment.  Sounds more to us like they have a multitude of problems; problems that will likely take a long time to fix.


European Banking Monitor: Financials Swaps Pull-Back

Below are key European banking risk monitors, which are included as part of Josh Steiner and the Financial team's "Monday Morning Risk Monitor".  If you'd like to receive the work of the Financials team or request a trial please email 

 

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European Financial CDS - 31 of 37 reference entities in Europe tightened on the week by an average of 5 bps. While the month-over-month change is still +11 bps, on average, it has moderated notably with this last print.

 

European Banking Monitor: Financials Swaps Pull-Back - chart1 Financials CDS

 

Sovereign CDS – Sovereign swaps were mixed last week with Italian swaps widening the most (+13 bps to 133 bps) and Portuguese swaps tightening the most (-6 bps to 190 bps). 

 

European Banking Monitor: Financials Swaps Pull-Back - chart2 sovereign CDS

 

European Banking Monitor: Financials Swaps Pull-Back - chart3 sovereign CDS

 

European Banking Monitor: Financials Swaps Pull-Back - chart4 sovereign CDS

 

Euribor-OIS Spread – The Euribor-OIS spread (the difference between the euro interbank lending rate and overnight indexed swaps) measures bank counterparty risk in the Eurozone. The OIS is analogous to the effective Fed Funds rate in the United States.  Banks lending at the OIS do not swap principal, so counterparty risk in the OIS is minimal.  By contrast, the Euribor rate is the rate offered for unsecured interbank lending.  Thus, the spread between the two isolates counterparty risk. The Euribor-OIS spread tightened by 2 bps to 7 bps.

 

European Banking Monitor: Financials Swaps Pull-Back - chart5 Euribor OIS Spread

 

Matthew Hedrick 

Associate

 

Ben Ryan 

Analyst

 

 

 


MONDAY MORNING RISK MONITOR: BALANCED

Takeaway: Our Risk Monitor is showing a roughly even mix of positives and negatives in the intermediate and longer-term trends.

Current Ideas:

 

MONDAY MORNING RISK MONITOR: BALANCED - 19 2 

 

Key Takeaway:

Our overriding message the last month has been one of caution. We overstayed our welcome on the short side by one week as the XLF had a nice (+3.5%) bounce last week, though that was following a 6.3% decline in the month leading up. The message from the summary table below is currently showing more green than red in the short-term and an even mix between red and green over the intermediate and longer-term durations. Based on this, we're taking the threat level down a notch this morning and characterizing the outlook as balanced based on our various risk monitor factors.

 

Financial Risk Monitor Summary

 

  • Short-term(WoW): Positive / 5 of 12 improved / 1 out of 12 worsened / 6 of 12 unchanged  
  • Intermediate-term(WoW): Positive / 5 of 12 improved / 4 out of 12 worsened / 3 of 12 unchanged  
  • Long-term(WoW): Negative / 3 of 12 improved / 3 out of 12 worsened / 6 of 12 unchanged

MONDAY MORNING RISK MONITOR: BALANCED - 15 2

 

1. U.S. Financial CDS -  Swaps tightened for 24 out of 27 domestic financial institutions for an average decline of 6 bps. In fact, US financials are now tighter by 10 bps on the month. The biggest improvements came from BofA and MS (both were -6 bps w/w). 

 

Tightened the most WoW: AXP, MTG, MBI

Widened the most WoW: TRV, MET, UNM

Tightened the most WoW: ACE, ALL, CB

Widened the most MoM: TRV, MET, SLM

 

MONDAY MORNING RISK MONITOR: BALANCED - 1

 

2. European Financial CDS - 31 of 37 reference entities in Europe tightened on the week by an average of 5 bps. While the month-over-month change is still +11 bps, on average, it has moderated notably with this last print.

 

MONDAY MORNING RISK MONITOR: BALANCED - 2 2

 

3. Asian Financial CDS - Indian bank swaps tightened by an average of 10 bps on the week and are now tighter by 17 bps on the month. Japanese financials were little changed on the week. 

 

MONDAY MORNING RISK MONITOR: BALANCED - 17

 

4. Sovereign CDS – Sovereign swaps were mixed last week with Italian swaps widening the most (+13 bps to 133 bps) and Portuguese swaps tightening the most (-6 bps to 190 bps). 

 

MONDAY MORNING RISK MONITOR: BALANCED - 18

 

MONDAY MORNING RISK MONITOR: BALANCED - 3

 

MONDAY MORNING RISK MONITOR: BALANCED - 4

 

5. High Yield (YTM) Monitor – High Yield rates fell 19.7 bps last week, ending the week at 5.83% versus 6.02% the prior week.

 

MONDAY MORNING RISK MONITOR: BALANCED - 5

 

6. Leveraged Loan Index Monitor – The Leveraged Loan Index rose 12.0 points last week, ending at 1866.

 

MONDAY MORNING RISK MONITOR: BALANCED - 6

 

7. TED Spread Monitor – The TED spread rose 1.8 basis points last week, ending the week at 22.6 bps this week versus last week’s print of 20.8 bps.

 

MONDAY MORNING RISK MONITOR: BALANCED - 7

 

8. CRB Commodity Price Index – The CRB index fell -0.4%, ending the week at 270 versus 271 the prior week. As compared with the prior month, commodity prices have decreased -3.2% We generally regard changes in commodity prices on the margin as having meaningful consumption implications.

 

MONDAY MORNING RISK MONITOR: BALANCED - 8

 

9. Euribor-OIS Spread – The Euribor-OIS spread (the difference between the euro interbank lending rate and overnight indexed swaps) measures bank counterparty risk in the Eurozone. The OIS is analogous to the effective Fed Funds rate in the United States.  Banks lending at the OIS do not swap principal, so counterparty risk in the OIS is minimal.  By contrast, the Euribor rate is the rate offered for unsecured interbank lending.  Thus, the spread between the two isolates counterparty risk. The Euribor-OIS spread tightened by 2 bps to 7 bps.

 

MONDAY MORNING RISK MONITOR: BALANCED - 9

 

10. Chinese Interbank Rate (Shifon Index) –  The Shifon Index fell 4 basis points last week, ending the week at 2.42% versus last week’s print of 2.46%. The Shifon Index measures banks’ overnight lending rates to one another, a gauge of systemic stress in the Chinese banking system.

 

MONDAY MORNING RISK MONITOR: BALANCED - 10

 

11. Chinese Steel – Steel prices in China rose 0.3% last week, or 10 yuan/ton, to 3,028 yuan/ton. We use Chinese steel rebar prices to gauge Chinese construction activity, and, by extension, the health of the Chinese economy.

 

MONDAY MORNING RISK MONITOR: BALANCED - 12

 

12. 2-10 Spread – Last week the 2-10 spread widened to 188 bps, 6 bps wider than a week ago. We track the 2-10 spread as an indicator of bank margin pressure.

 

MONDAY MORNING RISK MONITOR: BALANCED - 13

 

13. XLF Macro Quantitative Setup – Our Macro team’s quantitative setup in the XLF shows 0.6% upside to TRADE resistance and 1.2% downside to TREND support.

 

MONDAY MORNING RISK MONITOR: BALANCED - 14

 

Joshua Steiner, CFA

 

Jonathan Casteleyn, CFA, CMT

 

 


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Relied upon by big institutional and individual investors across the world, this granular morning newsletter distills the latest and most vital market developments and insures that you are always in the know.


Germany Confirms #GrowthSlowing

Takeaway: Germany’s IFO Business Confidence survey declined again in October.

German IFO Business Confidence declined for a sixth straight month in the October reading to a level not seen since December 2012. 

 

This reading is not only in line with declining trends across the German economy over recent months but also remains an anchor to our Q4 Macro theme #EuropeSlowing.  

 

Germany Confirms #GrowthSlowing - chart2


Commodities Weekly Sentiment Tracker

Note: Using the z-score in the tables below as a coefficient of variation for standard error helps us flag the relative market positioning of the commodities in the CRB Index. It is not intended as a predictive signal for the reversion to trailing twelve month historical averages. For week-end price data, please refer to “Commodities: Weekly Quant” published at the end of the previous week. Feel free to ping us for additional color.    

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1.       CFTC Net Futures and Options Positioning CRB Index: The Commodities Futures Trading Commission (CFTC) releases “Commitments of Traders Reports” at 3:30 p.m. Eastern Time on Friday. The release usually includes data from the previous Tuesday (Net Positions as of Tuesday Close), and includes the net positions of “non-commercial” futures and options participants. A “Non-Commercial” market participant is defined as a “speculator.” We observe the weekly marginal changes in the overall positioning of “non-commercial” futures and options positions to assess the directionally-biased capitulation risk among those with large, speculative positions.

 

The SOYBEANS, COTTON, AND GOLD markets experienced the most BULLISH relative positioning change in the CRB week-over-week

The ORANGE JUICE, SILVER, AND COPPER markets experienced the most BEARISH relative positioning change in the CRB week-over-week

  • Note that we are currently bearish on both copper and oil. On oil, we outlined our bearish case on in a few recent notes. Please see the links below for color:

OPEC's Next Move

  • To summarize, we consider formal production cuts out of OPEC’s November 27th meeting highly unlikely and think this expectation will disappoint as a bull catalyst.

Oil Has Further Downside Before the Bottom

  • The expectation for a supply/demand floor is not a near-term catalyst to backstop volatility-induced, real-time market moves.

We’ll be hosting a call tomorrow with an analysis of production costs for North American shale plays. In short, we believe consensus underestimates the rapid technological advancement in oil and gas extraction from shale resources. See the link below or email for access to the call:

 

REAL COST OF PRODUCING TIGHT OIL AND SHALE GAS: FACT VS. FICTION W/ SPECIALIST LEONARDO MAUGERI  

 

Commodities Weekly Sentiment Tracker - chart1 CFTC Sentiment

 

2.       Spot – Second Month Basis Differential: Measures the market expectation for forward looking prices in the near-term.

  • The CORN, WHEAT, AND COFFEE markets are positioned for HIGHER PRICES near-term
  • The COTTON, RBOB GASOLINE, AND LEAN HOGS markets are positioned for LOWER PRICES near-term

Commodities Weekly Sentiment Tracker - chart2 spot 2nd month basis

 

3.       Spot – 1 Year Basis Differential: Measures the market expectation for forward-looking prices between spot and the respective contract expiring 1-year later.

  • The CORN, SUGAR, AND WHEAT markets are positioned for HIGHER PRICES in 1-year  
  • The LEAN HOGS, LIVE CATTLE, AND COCOA markets are positioned for LOWER PRICES in 1-year  

Commodities Weekly Sentiment Tracker - chart3 spot 1Yr basis

 

4.       Open Interest: Aggregate open interest measures the amount of opened positions in all actively traded futures contract months. Open interest can be thought of as “naked” or “directionally-biased” contracts as opposed to hedgers scalping and providing liquidity. Most of the open interest is created from large speculators or participants who are either: 1) Producers/sellers of the physical commodity hedging their cash market exposure or 2) Large speculators who are directionally-biased on price.

 

Commodities Weekly Sentiment Tracker - chart4 open interest         

 

Ben Ryan

Analyst

            

 

 


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