Listless sales, fickle consumers, changing tastes and competition are making it harder for McDonald's (MCD) to sail along smoothly, as its latest earnings report shows. Though its profits were slightly better than Wall Street projected, revenue wasn't quite up to par.
The threats facing the Oak Brook, Ill., Big Mac seller aren't insignificant, but it's hardly an all-is-lost scenario. The House of Ronald, in fact, has a great deal going for it.
Big sales. McDonald's system will report in the neighborhood of $90 billion in sales for 2013. Last year the company averaged sales of $2.6 million at a U.S. store, trailing only Chick-fil-A among 50 fast food and fast casual restaurant operators cataloged by industry-tracking magazine QSR. That was more than twice the average for the group.
They're everywhere. Whether you're on the highways or in the city, you aren't far from a McDonald's. Another 1,500 to 1,600 are planned this year, on top of the 35,000-plus that already exist globally. As a result of its scale, it holds a substantial convenience advantage in these hurried-up times. It has more U.S. stores than Wendy's (WEN) and Burger King (BKW) combined.
Revamped stores. McDonald's is unquestionably trying to enhance experience, brightening up its stores with a large-scale remodeling plan. The contemporary look hasn't hit every shop yet, but another 1,000 or so will get a makeover in 2014. And it's clear when you visit a variety of stores that customer-service is being stressed. Yes, of course you'll still encounter surlier crew members, but staff often is much cheerier than they were in the recent past.
Money machine. Free cash flow will probably be around $4.6 billion this year. Its ability to reinvest in the business and to send money to shareholders doesn't make McDonald's unique, but it's a very impressive, consistent performer that keeps surprises for investors to a minimum. With a dividend yield of 3.4%, it trails only three other Dow Jones Industrial Average members. Its capacity for controlling costs leaves it with few superiors in the restaurant industry, with net and adjusted earnings margins well above average.
Shareholders get paid. Along with the dividend, which gets raised regularly, investors have had a consistent player that's averaged a 10% price increase annually in the past five years. Not bad, but this is where the situation actually starts to turn. McDonald's has trailed the market, measured by the S&P 500, for the past two years, and it's doing so again in these early days of 2014. It's arguably a case of a stock that will treat you well in times of crisis, although it may underdeliver in bountiful markets. If you like slow and steady, you probably can sleep easily on this stock. If you need more than that, think twice.
With that said, a few serious problems and potential risks have to be addressed eventually, some sooner than others. If they are, even partly, it's a plus for the shares. Notable trouble spots:
Nonexistent same-store sales growth. After years of monthly expansion in this important indicator, McDonald's hit a snag in 2012 with a negative number. Raggedness persisted throughout last year. While full-year comps edged up 0.2% in 2013, that was the result of an increase in average prices at the counter. In the U.S., it was about 3.1% higher than 2012, exceeding the national trend, CFO Peter Bensen said on a conference call.
However, the real headline here is a bad one indeed -- that traffic dropped 1.9%. The importance of this cannot be overstated, because it's a major concern McDonald's has to fix. In the 10-K annual report that followed fiscal year 2012, the company noted that guest counts had risen "in each of the last nine years." The streak is broken now, and it's a huge red flag. As it relies heavily on affordability, McDonald's can't continue hoisting prices at a pace that outruns the norm.
[See related: Why McDonald's caffeine problem is hurting its business]
McDonald’s named a new U.S. marketing chief this week, saying Deborah Wahl, who previously was with homebuilder Pulte (PHM), will take over the post. With competition for consumer dollars as fierce as it is, she'll have her hands full. If she succeeds with clever campaigns, the customer decrease can reverse, and you'd better believe that will be a critical area to watch in the months ahead. Also, McDonald's is planning to install high-density kitchen set-ups it hopes will hasten order preparation and fulfillment. Cutting order times may aid in at least getting some customers back.
Identity questions. The Mighty Wings promotion that got underway in the fall was a misfire, although it wasn't the only mistake of late. Last year saw too many products and too much complexity in the kitchen, COO Tim Fenton acknowledged. As CEO Don Thompson put it, some products "didn't resonate as strongly with consumers."
The company says it's getting it resolved, and it will have to.
And on a related note, the hatred factor. This is a constant, with critics attacking McDonald's for its food quality, the low pay for its workers and occasionally bad-acting suppliers. The company has stood fast for years against detractors, but longer term could potential diners go elsewhere? Can McDonald's ever quiet those who view it as nothing less than a public health threat?
It has made efforts to offer healthier goods, such as egg whites, and is working with the Clinton Global Initiative on a diet-friendly project. But still — McDonald's is what it is.
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