Are Investors Underestimating McDonald's?
In this podcast, Motley Fool analyst Jason Moser and host Deidre Woollard discuss:
The changing behavior of global eaters.
How McDonald's uses data to drive menu changes.
Snap's proclamation that social media is dead.
Motley Fool host Ricky Mulvey talks to Patrick Badolato, an associate professor of instruction at the University of Texas at Austin McCombs School of Business about what lurks in company footnotes.
To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.
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This video was recorded on Feb. 5, 2024.
Deidre Woollard: Golden arches haven't lost their shine. Motley Fool Money starts now. Welcome to Motley Fool money. I'm Deidre Woollard here with Motley analyst, Jason Moser. Jason, how's your Monday going so far?
Jason Moser: Hey, so far so good it's nice weather out there. How about you, Deidre?
Deidre Woollard: I'm loving our weather, but I'm thinking about our people in California who are having a bit of a tough weather time.
Jason Moser: Yeah. Cancel the final round of the Pebble Beach prom out there in California on Monterey. When the weather's that bad, you need to take note.
Deidre Woollard: Yeah, absolutely. Well, let's get into what's happening with the markets. Last week, big week, we had Meadow, we had Amazon, we had Apple, and mostly a pretty great week. This week we've got probably more earnings, but a wide variety of large company and maybe not your ones that are at the top of market moving, but really important to cover, one of them, McDonald's, you got to talk about McDonald's.
Jason Moser: Absolutely.
Deidre Woollard: Of course. I would say looking at the headlines versus look at the actual earnings sales, if you look at the headlines, it's going to be companies missing revenue targets. But I look at it., companies still able to deliver comparable sales, that increase every quarter at about a little over 4% in sales growth in the US in this quarter. Don't you think that sometimes McDonald's deserves a little more respect than it sometimes gets?
Jason Moser: I absolutely do. One of the reasons why I feel that way Deidre is because in my early days here, when I first got here at the Fool, McDonald's was the company I looked at and didn't give it that credit that it deserved. I thought, you what? That's yesterday's news, and people don't want McDonald's, now they're going to Starbucks and they're going to Chipotle or whoever. No, McDonald's absolutely deserves a ton of credit.
I'm not a big McDonald's guy myself these days but it's impossible to ignore the success that this company has had over the course of its existence. It's easy I think to view it as perhaps an older or more challenged brand here domestically particularly, but I think when you look at the numbers, they say otherwise and this is a company that still has a ton of brand equity globally. Just having had the experience of traveling and living overseas for several years, I definitely, saw that, I've seen that. You brought up the comps numbers, I think it's absolutely worth mentioning, US comps this quarter were up 4.3%, international operated markets up 4.4%. Their developmental markets they saw under performance there. A lot of that, they said, reflected the impact of the war going on in the Middle East right now and that's very understandable and there's some second order impacts that come from that as well. You got to give them a little bit of a pass on that, that's just something that's completely out of their control, like the weather so to speak. But when you look at shareholders who've held onto these shares over the last decade, this stock has returned 300%. Well ahead of the markets performance there. You attribute it to that brand equity I think but also it's a franchise model that's tremendous. They've got 40,000 plus restaurants, 95% of those are franchised. That doesn't gin up a ton on the top line compared to something a company owned operation like Chipotle for example. But what it enables them to do is really bring some impressive profitability down to the bottom line. You put that all together and just it's not a surprise to me to see McDonald's perform so well, but, it's one of those companies I think that a lot of people just, they'll look at it and just just keep on walking.
Deidre Woollard: I think it's true and you mentioned the franchises. I love to mention that it's always that it's a stealth real estate company. They own all of that land and that's very valuable and a good part of the company. But I wanted to talk a little bit about what you said there about the US. I feel there is that perception that people don't go to McDonald's, but then you look at their loyalty program. You've got 150 million members that have been active in the last 90 days, so that's huge. Twenty billion in sales in 2023 and I the way that they're pivoting things, they're constantly tweaking things. We think of them as burgers, the Big Mac they're making, the double Big Mac now. But chicken is as big as a sales driver for them and they're seeing that globally and they're trying to figure out, more of the world is interested in eating a chicken sandwich versus a burger, so how do we make a better chicken sandwich?. Now they're taking on coffee. It started with, it's just a cheaper way to get coffee in the morning, you get it, with your breakfast, that's great. But they're tweaking this too in interesting ways. I don't know, I the way they use data a lot.
Jason Moser: I do too. In this age of AI, we talk a lot about AI and all of the potential that it offers. Really the lifeblood of AI ultimately it's data, and we've seen these companies from Chipotle to Starbucks and everywhere in between utilizing these loyalty programs to really take advantage of getting as much customer data as they possibly can. What that ultimately does, it enables these companies to keep their customers within that universe and then cater offering specifically to those individual customers. I think we've seen the investments in technology really pay off as well. It makes me think of companies like Domino's and Papa John's. No, maybe those are the pizza concepts that many might have at the top of their list, given some of the local choices that exist where they may live, but the bottom line is they're very convenient, they're wonderful options and I have to tell you the investments in technology, they make it so easy to order. They have loyalty programs that keep you coming back for more and McDonald's absolutely taking advantage of that same dynamic. To your point on the chicken, I think that's important. In this age, we've really seen Chick-Fill-A take off and I think a lot of companies are trying to figure out ways to compete with a Chick-Fill-A chicken. Absolutely, a ton of growth there and I was reading through the call and the investments in the time McDonald's was put into this McCrispy chicken sandwich, it's really resulted in some serious drives to the business. They're talking about this is scaled to a one billion dollar brands across 30 markets worldwide. But now they also mentioned that chicken category represents $25 billion in annual system wide sales, which essentially puts it on par with beef, their beef offerings and they're sitting there also making these investments in making their burgers better as well at the same time. It does feel like while there's a ton of brand equity and a lot that they could probably just hit cruise control and just keep on moving forward, they don't seem to want to rest on their laurels. It's refreshing, I think, to see a concept like McDonald's really trying to up its game and compete with a lot of these fast-casual competitors out there today.
Deidre Woollard: Well, and they've had some swings that have missed in the past. We talked a little bit about Starbucks. McDonald's has this new concept, the cosmic, it's this cold coffee drinks and they've just tested it out, I think in about ten locations. Traffic's been pretty strong so far. Then I was listening to the Starbucks call last week and they were talking about the need to try to get people there in the afternoons. It seems like this afternoon thing is interesting, but I'm wondering. McDonald's has the room to play with things like this, but what do you think about that concept? Would you be driving through the Cosmics to get yourself an afternoon drink?
Jason Moser: If I was going by one, probably, I don't know that I'd go out of my way. But it also could be if I was going by one and I went by there once, maybe I would find it compelling and want to go out of my way for future trips. But I think it's important to note this Cosmic's offering. They identified. This $100 billion category. They quote across their top six markets that really focus on these beverages. It's not just beverages. If you look at the Cosmic menu, it is more than just beverages. Honestly, hey, listen, I could see those McPops doing pretty well. I don't know if you haven't seen them check that menu. The McPops look pretty good. But I absolutely love that they're trying this because again, I think in many cases, it's a matter of convenience. If they present a good offering and it's convenient, then people are going to give it a shot. If we look back through the history of something like a Starbucks, for example, that's a company that has started to recognize the benefits of convenience and incorporating more things like drive-throughs into their restaurants. McDonald's, I think has always been really known for, low prices convenience. This is something where they really specialize, and now they're starting to make that progress or that leap up into bringing a little bit more quality they're offering. Again, I think that menu with Cosmics, it's compelling, it's different, it's not just McDonald's. I think that will lead a lot of people to give it a shot. Then it's a matter of whether they find it compelling enough to keep going back.
Deidre Woollard: Well, and I think there's a whole new category emerging like Starbucks is trying to get people there for the drink and the snack. Other companies are starting to make these like later offerings that you come in for the drink in the snack option, especially in the afternoons. It reminds me a little bit of when they were trying to make, I think it was Taco Bell. They tried to make like a fourth meal. [LAUGHTER] I feel like they're trying to make another meal in here.
Jason Moser: It's the fourth or fifth meal, but it's at a different time of day. I think this is probably the time of day that more people can relate to. Because I think the fourth meal was probably geared toward people who have been out really late at night and have the munchies maybe on the way home. This seems like it's geared toward a little bit of a different audience and probably a bigger audience for that matter.
Deidre Woollard: Yeah, so thinking about Starbucks and McDonald's, the role of China is huge. Both of them are thinking about China. Late last year, McDonald's, they increased their minority stake in China to 48%. They opened 1,000 new restaurants, or actually a little over that last year in China all-time high. It's a pretty small percent of the business. But how are you thinking about companies that have this large consumer exposure in China right now? Because we've got geopolitical concerns there as well as some consumer weakness.
Jason Moser: Yeah, I think of the grand scheme of things, I view it ultimately as a positive, and I've said it before. When it comes to investing in China, I know what I don't know, investing in pure-play China just doesn't work for me. I've watched a play out over the last 15 years in how so much of this hype ends up sputtering out. With exceptions of course, but for the most part, it's just been a very difficult market to fully understand and I think really, honestly have faith in. But I think I view these multinationals, Starbucks, McDonald's, Apple, Coca-Cola, you name it. These are great ways to get satisfactory exposure to China without actually having to worry so much about the minutia. Not having to worry so much about what's going on over there. When you look at the state of the Chinese consumer today, I know things aren't all that great right now. I think there's reason to be hopeful though that the Chinese consumer will start seeing better days sooner rather than later. There's a lot of pessimism out there. Challenges from the COVID policies, and ongoing property crisis, that was a real 12 punch. High rates of youth unemployment, poor economic forecasts, you get the collapse of Evergreen. All of these things put together is there's just a ton of pessimism out there in regard to the Chinese consumer today. I think that's precisely when investors need to start looking because we know that things eventually will improve. Perhaps we're getting a little bit closer. For me, the ideal way to participate in an economy like that is going to be through the multinationals like your McDonald's and Starbucks of the world.
Deidre Woollard: Yeah. With McDonald's, you get a nice little dividend along the way.
Jason Moser: That's a very good point.
Deidre Woollard: Well, I want to pivot and talk about something else that is on my mind this morning. Did you watch the Grammys?
Jason Moser: I must admit I did not.
Deidre Woollard: Well, there was this commercial that caught my attention outside of the other controversies that may have caught my attention. It was this Snap commercial taking aim at TikTok and Instagram reels and basically saying social media is bad. Snapchat is good. It's this fun, happy place. We've got these like, oh look, I'm a broccoli face. It's interesting they had this big ads bend last night. They've got this new campaign. Then this morning they cut about 10% of their global workforce. They're reporting tomorrow. But I'm thinking about where they're taking their strategy. There was this leaked email last year that said that Evans Bagel sent out the CEO. Social media is dead, long live Snapchat. You talked about Meta on Friday on the show. Certainly, that is going nowhere from what I can see and from the earnings last week. But is there a case for the idea that social isn't quite as social anymore?
Jason Moser: I think there is to an extent. I think social is going to be with us in one form or another going forward. At least I'm going to have to imagine for the rest of my life. I think it's ultimately just a matter of what people are looking to get out of it. I do understand if folks are pulling back on the rains a little bit and maybe not being quite as social or sharing quite as much, we've seen that that stuff can certainly be used against you. It is absolutely impossible for me to buy into the notion that Meta is on the win. The portfolio of that strategy for them has really paid off, and we just saw that in spades here in the most recent core. Snap I think is in a little bit of a bind because they still really are just Snapchat. Up and coming generation likely isn't looking at it with the same rose-colored glasses that the previous one did. When you look at the numbers, revenue growth has hit a wall. Again, like you said, Meta's report tells us there's still plenty of growth out there to be had. I was interested to look at Snap and compare it to Twitter at a certain point of time to get an idea of where these two businesses were. You look at Twitter, which was acquired in the back half of 2022. But if you look at Twitter's revenue in 2022, they generated a little bit better than $5 billion in revenue, and Snap still hasn't even gotten there, and that's Twitter. A company that I think many would argue myself included, left a ton of money on the table for just a number of various self-inflicted reasons. There are some lessons learned from Twitter to me, Snap rhymes. I think when you look at the overall opportunity out there, shoot, Amazon ad revenues up 27% of the quarter. That advertising revenue is definitely out there. It's companies like Snap I think are having a little bit of a more difficult time realizing it these days because social is such a difficult space when you're competing against Meta. But I think the question really for Snap investors at this point is, what are you ultimately expecting from this company? Do you think it's going to grow or is this something else? Do you feel like it's going to be acquired? Because I think the growth question is a very fair one, particularly given what we've just seen play out here in the early parts of emergencies.
Deidre Woollard: Well, thanks for breaking down with me today, Jason.
Jason Moser: Thank you.
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Deidre Woollard: Last year Uber changed the way it counts revenue and the difference may have an impact as the company reports this week. Ricky Mulvey caught up with Patrick Badolato, an Associate Professor of Instruction at the University of Texas at Austin McCombs School of Business, to discover what investors can find out beyond the headlines and in the footnotes.
Ricky Mulvey: We talk a lot about headlines coming out of earnings, the big reporting numbers. But right now you want to focus on the footnotes. These are at the bottom of the page as we go through earning season, why are the footnotes even worth an investor's time to check out?
Patrick Badolato: Sure, Ricky, I love that question and let me step back real quickly which is I'm going to refer to the footnotes as like all of the broad, qualitative, sometimes quantitative information that's in addition to the financial statements. Not what's on the financial statements, not the main core financial metrics, but I think they're massively informative because they give additional insight and flavor and sometimes really critical details about updates and changes that it's just we're going to be more informed walking into earning season or really any other assessment of a company if we've spent a little bit of time. My class, I used the phrase, read good but spend the time to avail yourself to the footnotes, the other information outside of the financial statements because it's packed full of useful Tibbets of information.
Ricky Mulvey: Sometimes they can be hard to parse through if you're not an accounting professor. Sometimes there's some gold in there. We're trading emails before this and you said there was a classic example from Apple.
Patrick Badolato: Yes, let your first point I want to address and I want to give the Apple example but that's the big challenge which is like, 10K is what, 120 pages long, and that's one pre IPO filing something the same. Most of it, so much of it is too much of it, if I can give my opinion is boilerplate where you're reading stuff and I'm not really changing anything. The challenge is though, the nuggets and the insights are there, they're just not easy to find and yes, I'm an accounting professor, I like reading these things and I'll put my time into reading the whole thing. But it's what I try to convey in a class and I want to use the Apple example is what I teach even at the Intro Financial Accounting level, is the footnotes are there and at times you want to grab them to think about it. The classic one I've done over time and this is not specifically recent news, but Apple's got a great footnote on its accounts receivable and that has nothing to do with what's reported on the balance sheet. It's just there's a footnote that talks about it. I think it's page 40 of their 2022,1K and they give a comment to the effect that what they're doing is they're requiring all smaller scale retailers to go out and get like third party insurance so that Apple will sell to them on account. But the reality is that the retailer has to go and get backing so that if the small retailer is not able to pay Apple, Apple is still going to collect effectively insurance proceeds so they're going to get their cash either way. The footnote shows us that, like Apple has virtually no risk of collection with its account receivable reported on the balance sheet, not on the balance sheet. There's nothing about that there. Read the footnote and you realize maybe that's something you would expect for a behemoth like Apple but really no risk of collection given the way they structure their deals with any smaller retailer.
Ricky Mulvey: Is that something that's rare among companies? I could imagine a lot of companies, they want to get the cash that they're entitled to on that account. But I don't know of any other companies that do that.
Patrick Badolato: Yes. Great question. I wish I had a better answer and I don't like how many use it, how many don't? I worry that the classic answer is just like, well Apple could do it at once because it's in such a position of strength. But I'll give you a personal finance example of this that I usually try to talk about in class which is, this is very similar to what we may face when we're getting a mortgage with PMI or private mortgage insurance. The bank's going to require us. We put less than 20% down to go pay for PMI insurance or private mortgage insurance. If that's so that the bank still collects its mortgage payments effectively, if we were to fall or miss a payment or something like that and it's crazy to think about it but it's similar, whether it's like you have one very powerful player, the bank giving us a mortgage and one far less powerful entity, us, the homeowner and the argument is you're going to basically make the smaller player pay the insurance to protect the larger player. That's what Apple's doing a version of that with its accounts receivable, ensuring it collects.
Ricky Mulvey: When you're one of the biggest companies on the planet, it's easy to know that other companies need you more than perhaps you need it. Uber is reporting tomorrow. This is a more recent example. Last year, the company changed how it treats discounts and promotions. We're talking about it. I think you said this was an important change, so what happened? What they do?
Patrick Badolato: I think for this one, it's worth stepping back again and talking about the way they laid things out with their initial IPO filed in 2019 and there's a lot of layers and there was a lot of conversations but I want to just get to the point which is, they did not call. If you've taken Uber, you've got Uber eats delivered or you've taken a ride to go somewhere with Uber, I certainly have done that but we are not Uber's customer. In their IPO, we were not their customer. We were called riders or end users. Their customer, consistent with their IPO document was the driver, the driver driving the car providing transportation and that may seem weird, but that's the genesis of this whole idea. In their IPO, they had a bunch of promotions and discounts that were issued to the rider or the end user and they were actually booking that as both revenue and then offsetting it with sales and marketing expense. I think it was rounds to $3,000,000,000 in 2017 and 2018 combined in the two years preceding their IPO. But $3,000,000,000 and I'm not this is legal, there's a way that this works out it's because the riders were not their customers. But to simplify it, maybe over simplified. It's similar to saying that they were effectively buying their own services and that's what it works out to. If they gave a ride or $120 coupon, that $20 coupon was counting as revenue. It was removed via sales and marketing expense so no effect on like operating income but still an opportunity to increase revenue, to boost the revenue growth in the early stages of the company.
Ricky Mulvey: Now the revenue is not comparable and maybe you'll even see a slight revenue decline as they make this change. Why do you think Uber is making it?
Patrick Badolato: Yes, and so let's just be specific about the change too but then I definitely want to offer some lens into what we can think about before the 2023 earnings come out. What they changed in the second quarter of 2023. I actually think based on the numbers, it was like toward the end of the second quarter, but I don't know the exact date. But they changed in the second quarter of 2023, is in many of their major markets, it looks like it's roughly two thirds using the third quarter numbers, but they now are classifying the rider effectively as a customer. As they're classifying the writer as a customer now, that actually means that if they give promotions and discounts, which they're continuing to do, it's not a removal of promotions and discounts, but now they're not counting the promotions and discounts as revenue and they're also not offsetting it as a marketing sales and marketing expense. Ricky you already alluded to this, and I just want to flesh it out a bit more. The challenge here is this change occurred mid year, roughly. It's going to be hard to compare anything coming out tomorrow with 2023's numbers, with anything that happened in 2022 or any prior years. Even within 2023 because the change didn't happen at the beginning, it might be hard to think about quarter to quarter comparisons or year over year comparisons. In this case to reiterate your point, revenue will actually be smaller because they're not including, and I think in quarter three it was $521 million. That just one quarter $521 million that would have been in revenue is not there and also is going to be removed from sales and marketing expense. The year over year revenue growth, all else held equal is going to be lower. It's just going to be harder to achieve any growth because stuff that was classified in revenue is no longer classified that way.
Ricky Mulvey: Maybe there's a tide to the story where Kashrashahi he comes in as the CEO of Uber, wanting a leaner, more focused company and maybe take away some of that noise in the S1. I know we've made fun of it on the show in the years past. The total addressable market was four billion people, or basically everybody in the 63 countries that it operated in at the time. Do you think that with this move in the footnotes, the way that Uber is changing the way it counts revenue, is that part of the story here with the company as it is today?
Patrick Badolato: I love that question and I want to elaborate on it. But I think there's one more level and I hate to be nip picky about this too.
Ricky Mulvey: Go for it. You're the professor.
Patrick Badolato: That sales and marketing expense is also going to go down. I just caution, it's not a criticism of Uber in any way, but just preparing us for what we're going to see is that year over year sales and marketing expense should also decrease using the third quarter number alone by that 521 million. It'll be more than that because we don't have the fourth quarter information yet. But the sales and marketing expense will decrease as a dollar amount and also will decrease as a percent of revenue. I mentioned that we're going to see like margin improvement, where one expense decreases as a percent of revenue. It's not good nor bad. It's just a result of this reporting change. Worth being informed when we walk in there because we don't want to be saying is, wow, look at this great efficiency improvement with sales and marketing. They must be getting better at promotions and discounts or marketing. I'm not in any way saying they're getting worse. But no, the data just mathematically will lead to sales and marketing expense decreasing as a percent of revenue. That's like efficiency. That's worth understanding the reporting behind. But Ricky, I love your other question. I want to flush it out a bit more as well. I was pretty critical, looking at Uber in the pre IPO stage and we've done a bunch of classes and offering that there's a lot of questions and confusion and seem like distractions. Then COVID hits and just up ends everything. Which, you know, is tough for so many different companies.
But I think the Uber that emerge, it's really fascinating business model and I think they've figured out what they are, the phrase I use and I talk about them in classes, this is not a replacement for individual car ownership. This is not a target market of four billion people, but what they are is a platform of convenience. A company that can offer us rides when we need rides, can offer us goods. I applaud the fact that Uber eats has become so inclusive of not just fast food, restaurant meals, but you can get delivered groceries and florists and all these other things, which I think makes it more convenient for the customer. But also a better, driving opportunity, better utilization for the driver. I think that focus on the core and getting away from the autonomous and the replacement for individual car ownership is a massive step in the direction. Still questions, still stuff to figure out. But that core competency, the platform of convenience, we like convenience, we like stuff, we like getting places and getting things delivered to us. That may be a successful move in many ways for them. It seems like it is.
Ricky Mulvey: Maybe you're checking out the footnotes in a report. I think one piece of research you shared with me that is worth investors attention though, that they can track for the companies that they own and follow is the risk factors and an annual report. There are some researchers that found that how companies management changes the risk factors and changing their wording can often predict maybe future trouble for the company. And that section is worth a little bit more attention.
Patrick Badolato: I agree. I say that my thoughts on reading the literature and everything, it seems like reading the footnotes is still not that commonplace, full of information. But I love teaching it because, hey, that's your possible chance for differentiation. The change in the language, what's there. I agree, sometimes the risk can be informative. I love the way they were looking at it in that study, but I'll offer a few other areas I think are worth checking out. We gave the specific discounts and promotions and sales and marketing with Uber. But some other ones I strongly recommend is first and foremost actually owner rank this, the segments. Look at the segments of the business. Segments move in different directions. This is true for Uber. Their freight segment during 2023 has been going down year over year decline in revenue growth. Where deliveries and mobility, those are growing at different rates. Companies have segments that don't just do one thing, read as much as you can off the income statement or the financial statements to find out about segments. Another one, is MDNA management discussion and analysis. They don't always give you everything you need, but often there's that movement, Hey, here's factors that contributed to a trend. Factors that offset. Granular data that gives us a little bit more about like, let me know a bit about the story behind it. Revenue recognition, which I would argue is massively important for Uber and it's S1 are realizing wait, who's their customer? How do you do this? Then if you have companies with revenue recognized over time or have some discretion on are they the agent in the transaction or are they the main provider? There's more there as well. Risks looking at debt footnotes can be certainly informative in cases like Silicon Valley Bank and others. Taxes in certain cases. Really try to figure out what's valuable for the company and then use the footnotes is like, hopefully, you're thirsty for. I want to get more information. I want to get granular data on what's there.
Ricky Mulvey: Patrick Badolato is a Professor of accounting and finance at the McCombs School of Business at the University of Texas. Thank you so much for your time and your insight.
Patrick Badolato: Thank you, Ricky. I really appreciate it.
Deidre Woollard: As always, people on the program may have interest in the stocks they talk about. The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solve on what you hear. I'm Deidre Woollard, thanks for listening. We'll see you tomorrow.
John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Deidre Woollard has positions in Amazon.com. Jason Moser has positions in Amazon, Chipotle Mexican Grill, and Starbucks. Ricky Mulvey has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Amazon, Chipotle Mexican Grill, Domino's Pizza, Starbucks, and Uber Technologies. The Motley Fool has a disclosure policy.
Are Investors Underestimating McDonald's? was originally published by The Motley Fool
