Consistent with our short thesis, MCD gave an uneventful presentation this morning at the UBS Global Consumer Conference. Despite the stock being bid up since the announcement of former CEO Don Thompson’s retirement, there has been little incremental news suggesting radical change. With the stock well ahead of the fundamentals, we think it offers an attractive short-term trading opportunity. MCD is currently trading at a seven-year peak multiple of 20x P/E, despite the numerous challenges the business continues to face across the globe.
While we do understand the hype, we believe it is misplaced. We don’t see any near-term catalysts on the horizon; a belief that, in our view, was validated during today’s conference by the following:
- MCD continues to face challenges in important markets, such as the US, France, Russia, China, and Japan
- MCD will take a while to turn around and results will remain volatile
- MCD still has an image problem
- MCD will continue to expand the Create Your Taste platform
- MCD is facing a lot of pressure to raise wages
- MCD is playing “catch up” on the technology front (digital, mobile, loyalty, etc.)
- MCD’s owner operators are still struggling
- MCD is unlikely to increase its leverage
- MCD is unlikely to pursue an “OpCo-PropCo” split (at least in the near-term)
The business is facing too many headwinds for the stock to be trading at such a premium multiple. Given the lack of major news flow we see coming out of McDonald’s in the near-term, we believe the stock is ripe for a trade on the short side. Considering high expectations, those hoping for a major strategic announcement are likely to be disappointed.
03/02/15 03:06 PM EST
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 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:
- The Board, similar to the menu, needs to be overhauled.
- Franchisees are clearly disgruntled – will they support the new CEO?
- 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.
- Wage inflation for MCD and all quick service peers will accelerate for at least the next two years.
- MCD has the highest AUVs in the quick service space – why do they have issues with franchisee profitability?
- 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?
- MCD has an image problem.
- 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:
- Leveraging the balance sheet to recapitalize the company.
- Intent to significantly selloff a significant number of company-operated stores.
- A new product silver bullet.
- 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:
- A revamping of McCafe – exiting the business of selling espressos.
- Ending the Create Your Taste test.
- 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?
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.