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MCD: LONG ROAD AHEAD

We’re confident MCD will return to being a great company one day.  But right now, it’s too early to call that turn – there’s a significant amount of work to do.  More important, it’s yet to be determined if the new CEO is willing to make the difficult decisions necessary to move forward.

 

With that being said, we are adding MCD to our Investment Ideas list as a short.

 

MCD: LONG ROAD AHEAD - 1

 

MCD has risen ~11% since Steve Easterbrook was named the new CEO on January 28th, 2015.  This week, he’ll be communicating his vision for the future of MCD at the “Turnaround Summit” in Las Vegas.  Importantly, Mr. Easterbrook has only had ~32 days to circle the wagons and come up with a plan that will convey change and layout a vision for the future.

 

We suspect we won’t see the radical changes needed to set MCD on a better path anytime soon and, as a result, believe the stock is way ahead of itself. 

 

Below is a laundry list of issues, or questions, the company is facing:

  1. The Board, similar to the menu, needs to be overhauled.
  2. Franchisees are clearly disgruntled – will they support the new CEO?
  3. Over the past 10 years, MCD has systematically and regularly added costs to the franchisees’ P&L without considering the long-term impact of these costs.  These expenses are over and above rising wage rates, beef inflation, etc.
  4. Wage inflation for MCD and all quick service peers will accelerate for at least the next two years.
  5. MCD has the highest AUVs in the quick service space – why do they have issues with franchisee profitability?
  6. MCD could sell company-owned stores, but will it have an impact on profitability?  Will they actually do it?  Should they be closing stores instead?
  7. MCD has an image problem.
  8. MCD’s direct competitors (both traditional quick service and new fast casual upstarts) are well managed, well capitalized, and growing.

 

Recent action in the market appears to be signaling high expectations for the MCD “Turnaround Summit” in Las Vegas this week.  We suspect the news flow exiting this event will be lacking the detail needed to support the current move in the stock. 

 

In our view, the news needed to support the stock move would be:

  1. Leveraging the balance sheet to recapitalize the company.
  2. Intent to significantly selloff a significant number of company-operated stores.
  3. A new product silver bullet.
  4. A significant cut in G&A and downsizing of the home office.

 

We don’t think any of these are a real possibility in the coming weeks.  Instead, we believe we’re likely to hear something closer to the following:

  1. A revamping of McCafe – exiting the business of selling espressos.
  2. Ending the Create Your Taste test.
  3. Slowing unit growth – which has already been announced.

 

The real issues the company needs to address will likely not be addressed anytime soon:


Board of Directors

For the most part, MCD’s board has served the company well, but significant change is long overdue.  Andy McKenna, the current executive chairman, is 84 years old.  While Mr. McKenna has served the company very well over the years, it is time for him to pass the torch to the next generation.  Once the board is reconfigured with new thinking, it then must decide what the McDonald’s brand represents to consumers – and aggressively go after it.

 

As soon as MCD begun feeling pressure from SBUX, the brand has lost its focus and evolved into trying to be all things to all people.  Therefore, many of MCD’s wounds today were self-inflicted and, in fact, many are reminiscent of the issues the company faced 10 years.  How did this board let history repeat itself?

 

McDonald’s Image Problem

The perception of the McDonald’s brand is worse now than ever before.  This perception cannot be fixed quickly and will likely be very expensive.  The question some are asking is: is MCD to fast food what IBM is to technology?  For the past five to six years, there has been no clear direction coming from the executive suite, leaving the business in a hole that will be very costly to dig out of.

The biggest “public perception” problem the brand faces has been from over-indexing the brand on discounting and selling cheap fast food.  The $1 menu has been very destructive to the company and will be difficult to change.  This suggests the company may need to put part of its past behind it.  Does MCD need to move on from the Ray Kroc era of selling cheap food fast?

 

Owner Operators

The owner operators are the key to a potential McDonald’s turnaround.  Currently, a majority of owner operators are in a difficult position thanks in large part to increased debt levels.  It’s clear to use that when the owner operators are making money and growing their business, shareholders are rewarded.  Owner operators are struggling mightily in the current environment; morale is at historically low levels as increased rent, wages, etc. are increasingly difficult to pay. 

 

Higher wages, which are inevitable, will only erode franchisee profitability.  Ironically, at the same time, it will benefit McDonald’s profitability, since franchisees will be forced to raise prices.  But franchisees must be very prudent with their price increases, because a significant percentage of McDonald’s employees are value conscious and will adjust their spending patterns accordingly.  Owner operators are the best brand ambassadors and their lack of enthusiasm will make a turnaround very difficult to achieve.



McCullough: Why You Should Take Warren Buffett’s Advice With A Grain of Salt

 

In this excerpt from today’s edition of RTA Live, Hedgeye CEO Keith McCullough reminds viewers that legendary investor Warren Buffett wasn’t always the buy-and-hold maven he is today (think back to 1987…)

 

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(More) Bad Economic News in Japan = Nikkei Rips Higher

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Another horrendous economic data point in Japan with Auto Sales down -14.2% year-over-year in February. So… how did Japanese stocks handle the news? They’re making another fresh, 15-year high.

 

The Weimar Nikkei is up +8% year-to-date, moving up another +2.3% on the week (S&P 500 was -0.3% last week).

 

Nikkei loves Burning Yens!

 

(More) Bad Economic News in Japan = Nikkei Rips Higher - y88


QUICK TAKE | McCullough: My Latest Thoughts on Whether a Recession Is Coming

 

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LEISURE LETTER (03/02/2015)

TICKERS: RCL, WYNN

 

EVENTS

  • Mar 5: The 3rd Session of the 12th National People’s Congress (NPC), China’s top legislature will convene in Beijing

HEADLINE NEWS

  • RCL - announced today that it has entered into an agreement to sell its cruise ship Splendour of the Seas to TUI Cruises in 2Q 2016. The ship will then be leased to Thomson Cruises, which will operate the vessel. "The ship's sale is in line with our strategic objective of divesting ourselves of older hardware and keeps us firmly on the course to the Double-Double," says CEO Fain. 

Takeaway: One way to deal with cannibalization risk is to sell the underperforming ships. The last time RCL sold a ship, (Celebrity Century Sept 2014) it was at a $17.4 million loss. Splendour itineraries are in Europe and Dubai.

COMPANY NEWS 

WYNN -  “The board decided not to re-nominate Elaine P. Wynn to serve as a director, based on the recommendation of the Nominating and Corporate Governance Committee,” said a company filing. But the document said Ms Wynn intended to nominate herself for election by shareholders even if the board does not support her. The board meeting is on April 24.

 

Starwood Capital/Melia -  announced today that they have established a joint venture that has agreed to acquire a collection of hotels across key resort locations in Spain. The initial portfolio for the joint venture consists of seven well-established beachfront hotels representing 2,933 keys that are currently owned by Melia Hotels International and will continue to be managed by Melia upon completion of the transaction. The properties will be acquired by the joint venture in a transaction valued at €176 million ($198 million), subject to the approval of the European Union Merger Control Office.

 

RCL - A guest on Royal Caribbean's Liberty of the Seas is reporting the ship is experiencing propulsion problems that is forcing the ship to travel at a reduced speed.  As a result of the slower speed, the ship has canceled a scheduled port stop in Ocho Rios, Jamaica and will instead head back home to Fort Lauderdale.

 

The report has not been confirmed by Royal Caribbean yet but the guest did indicate Royal Caribbean is issuing an onboard credit of $100 for inside staterooms and $200 for balcony staterooms for the inconvenience.

ARTICLE HERE

Takeaway: If true, another headache for RCL

INDUSTRY NEWS

Hotel room rates drop for Lunar New Year holidays - The average room rate in Macau’s three-star, four-star and five-star hotels was MOP2,019 (US$252.75) during the Lunar New Year holidays this year, 15.4% less than in the equivalent period last year, the Macau Government Tourist Office says, citing data from hoteliers. 

 

The average occupancy rate of such hotels fell by 6.9% points to 87.5%. The average occupancy rate of two-star hotels fell by 13.4% points to 73.9% and the average occupancy rate of guesthouses fell by 8.6% points to 74%.

ARTICLE HERE

Takeaway: Not a good sign as we wait for the final monthly numbers for February. The only bright spot in Macau was supposedly strong hotel bookings.

 

S'pore Changi Airport- passenger traffic for January 2015 fell 3.8% YoY.

LEISURE LETTER (03/02/2015) - changi

Takeaway: Bad start to new year

MACRO 

Hedgeye Macro Team remains negative Europe, their bottom-up, qualitative analysis (Growth/Inflation/Policy framework) indicates that the Eurozone is setting up to enter the ugly Quad4 in Q4 (equating to growth decelerates and inflation decelerates) = Europe Slowing.

Takeaway:  European pricing has been a tailwind for CCL and RCL but a negative pivot here looks increasingly likely in 2015.



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