We are moving McDonald’s (MCD) from the LONG bench to the SHORT bench.
We recently moved McDonald’s to the SHORT bench as a reflection of our thoughts that the stock will underperform in 2017. We don’t believe there is significant downside, but our confidence in the company’s ability to drive U.S. same-store sales in 2017 has diminished. Specifically, MCD’s announcement that they are going to double down on McCafe in 2017 could cause operational issues and not generate the positive outcome the company anticipates.
On November 10, 2013, we published a note on McDonald's titled “McDonald's Obsession with Starbucks.” At that time, our bearish thesis on MCD revolved around our “espresso-based conspiracy theory” which was the root of McDonald’s sales issues. Despite how hard McDonald's management team has tried, MCD will never be what Starbucks is: a leading destination for espresso-based beverages or even a “third place.” In the process of trying to sell expresso drinks, like SBUX, MCD was hurting its core business of selling food!
Our bearish bias turned bullish in July 2015, after Steve Easterbrook became CEO and the company got back to its roots of selling food. Following the company’s 2015 Bi-Annual analyst meeting in November 2015, we wrote a note titled “The Day McCafe died.” What interested us the most about the McDonald’s 2015 analyst day was not what was said, but what was left unsaid. The biggest operational change was the gradual shift away from beverages. The word “McCafe” was never mentioned by the CEO, Steve Easterbrook, or even by Pete Bensen, the Chief Administrative Officer at the time, and Mike Andres, former President, McDonald's USA.
The first mention of McCafe came from Kevin Ozan, Chief Financial Officer, when he said, “We seek to balance new store investment, where we have historically earned higher rates of return with investments in existing restaurants that has included reimaging, initiatives such as the expansion of our beverage business and McCafe, and general maintenance CapEx.”
Compare this to the 2013 analyst meeting when “McCafe” or “coffee” was mentioned 92 times!
In 2015, the shift away from McCafe was evident and the emphasis on selling food was now a key operating strategy. At that time, the head of MCD USA was Mike Andres and he was known as a “food guy.” Mike’s comment from the 2015 analyst meeting says it all: “We are a restaurant company. We must and will win with our food. Our customers tell us that they want our food to taste great and they want to feel good about eating it. They want to know what's in their food. Where it comes from and how it's made. While we are very proud of the quality of the food that we serve today, we know we can do better. We have a committed attitude around real and fresh, specifically around the ingredients and the evolution of the menu.”
Unfortunately, in August 2016 Mike Andres retired from McDonald’s amid rumors that he and the CEO did not get along. We are now guessing that the rift between the two was partly because the CEO wanted to double down on the McCafe strategy in 2017.
The original rollout of McCafe was the most expensive project the company has ever undertaken! The McCafe brand has some goodwill with customers, but the company will never be successful selling espresso based drinks. The original McCafe strategy was a failure and ultimately cost then CEO Don Thompson his job, and according to a number of press reports, in 2017, MCD is going to try its coffee strategy again.
Under what scenario will McCafe 2.0 be a better, more productive sales driving strategy?
Apparently, McDonald's plans to spend tens of millions of dollars in restaurant remodeling and millions more in marketing to roll out a new McCafe starting in 1Q17. This suggests that the company will once again shift marketing dollars away from food and put it toward beverages. Does this mean they will be promoting a line of beverages which includes “hot” espresso drinks in the summer of 2017? How do they think this strategy will work against the runaway success of selling all-day breakfast in 2016? Or was the mild winter the real reason for the positive same-store sales in 1H16?
We will have more details as they unfold, but for the time being we are cautious on the company’s current sales driving strategy and potential operational challenges.
Please call or e-mail with any questions.
Howard Penney
Managing Director
Shayne Laidlaw
Analyst
