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Streamlining Won’t Boost McDonald’s Corporation Long Term

Will Healy

McDonald’s Corporation (NYSE:MCD) has begun to focus on a turnaround. The world’s second-largest fast-food chain has seen store traffic drop amid changing food trends. Now, the company plans to lay off workers and put in a new field structure to better support franchises. However, the price of MCD stock has not reflected these and other struggles. Given increasing valuations and falling revenues, investors should avoid McDonald’s stock.

To be sure, McDonald’s needs to change its approach. Company revenue peaked in 2013 at $28.11 billion. It has fallen every year since. Consensus revenues for 2018 now stand at $21.23 billion. Performance looks better from a profit perspective. Though profits have not increased every year, Wall Street predicts MCD will earn $7.70 per share this year.

The company manages to accomplish the profit increases despite the decline in revenue. In 2013, MCD stock earned $5.55 per share for its stockholders. During this time, the company has reduced its cost of revenue by 30%, allowing for the increased profit.

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Cost-Cutting Will Not Help MCD Stock in the Long Run

Now, the company seeks to increase profits by — you guessed it — more cost-cutting. But when the company has already cut its cost of revenue by 30% over the last five years, how much the company can afford to cut remains unclear.

Another disturbing trend from company financial statements remains its debt level. At the end of 2013, long-term debt stood at $14.13 billion. That figure has seen steady increases since. As of the end of the first quarter, that debt level had risen to $30.87 billion. Over the same period, total stockholders’ equity has fallen from $16.01 billion to -$4.72 billion.

Despite negative equity, the MCD stock price has risen by almost 80% since the end of 2013. While this increase lags the S&P 500, it hardly reflects the worsening financials of McDonald’s. The price-to-earnings (PE) ratio of MCD stocks stands at just under 29. This remains well above MCD’s average PE of about 22.

MCD Needs to Adapt to Changing Tastes

Worsening financials will not be improved by this or any attempt to streamline its business. If MCD wants to address declining revenues, it will have to acknowledge a harsh reality — the public wants less of what McDonald’s currently offers.

Some say the public’s increasing focus on avoiding processed food has likely undermined sales. Still, offering healthy options such as salads has not stemmed revenue declines. The company also operates in more than 100 countries. Hence, MCD has only a limited ability to further international expansion.

However, a 25% revenue decline would imply that 75% still enjoy its food. That leaves options. One approach could involve embracing the lower demand. The Cola-Cola Co (NYSE:KO) increased revenue per ounce of its sodas by offering smaller sizes. By the same token, MCD could embrace smaller meal sizes.

The company also could provide a version of its food with fresh, organic ingredients. An indication this could succeed lies in the strategy of one of its past investments. MCD once owned a stake in the fast-casual restaurant Chipotle Mexican Grill, Inc. (NYSE:CMG). Chipotle, along with restaurants such as Potbelly Corp (NASDAQ:PBPB) and Shake Shack Inc (NASDAQ:SHAK) found success as a fast casual establishment. The boom in fast casual shows Americans still want fast food. What they do not want is the low quality often associated with fast, lower-cost food. McDonald’s should take notice.

Bottom Line on MCD stock

No matter what changes McDonald’s makes, investors should not view cost-cutting as a long-term growth catalyst for MCD stock. McDonald’s cost-cutting measures could boost profits in the short term. However, MCD has engaged in cost-cutting for years amid declining revenues. In the long run, revenues must again rise to ensure the future of McDonald’s. For now, the company’s increasing debt levels and negative stockholders’ equity bode poorly for the future of the company.

The public may see Big Macs and fries as guilty pleasures. But they often perceive the food as low-quality and unhealthy. As a result, they increasingly avoid McDonald’s restaurants. In time, these revenue declines will affect the stock price. Until the restaurant offers more of what the public wants, investors should avoid MCD stock.

As of this writing, Will Healy did not hold a position in any of the aforementioned stocks. You can follow Will on Twitter at @HealyWriting.

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