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Analysts: McDonald’s turnaround will take time

Analysts: McDonald’s turnaround will take time

The burger giant has work to do to fix its sales woes

McDonald’s Corp. unveiled this week a host of efforts to make its restaurants more palatable to consumers, following perhaps its worst quarter in more than a decade, but analysts are skeptical the efforts will yield short-term results.

Of particular concern is not simply that McDonald’s U.S. same-store sales fell 3.3 percent during the third quarter, but that it is far behind its competitors. Company executives on a conference call Tuesday said that its sales gap with competitors in September was 630 basis points.

That gap is uncharacteristic of the world’s largest restaurant operator, wrote Bernstein Research analyst Sara Senatore, and speaks to deeper troubles.

“McDonald’s (same-store sales) trends hint at deeper issues that threaten its business,” Senatore said. “Competition has become (somewhat uncharacteristically for McDonald’s) a persistent drag on performance.”

A number of analysts say McDonald’s, after more than a decade of seemingly unstoppable growth, has entered a down period in its cycle, and that recovery won’t be easy.

Jefferies analyst Andy Barish wrote that he sees little potential for a near-term turnaround, given the U.S. weakness and the improving outlook for the rest of the industry.

“After 10 years of impressive growth, McDonald’s has entered a period of secular decline in our view,” Barish wrote. “There’s no silver bullet to recapturing traffic losses, and we worry that flattish/down same-store sales and margin squeezes are the new norm.”

The bigger question is whether McDonald’s efforts to fix these problems will yield results. President and CEO Don Thompson said on the company’s conference call this week that the chain wants to simplify its menu, beginning in January, to emphasize favorite items.

It also said it would enable operators to tailor their menus toward local tastes. Under new U.S. president Mike Andres, the chain plans to restructure the domestic organization to provide for more decision-making autonomy at the local level. The company has already started doing that by making the McRib limited-time offer a local and regional menu decision, rather than a national one.

In addition, McDonald’s is furthering its plans to give consumers the ability to customize their burgers. The company plans to expand the test of its build-your-own burger model, called “Create Your Taste,” in which consumers use touchscreen kiosks to pick their buns and toppings.

Both localization and customization of menus have been popular trends, and McDonald’s efforts could be a response to the mounting competitive threat from fast-casual chains like Chipotle, which reported this week a 19.8-percent same-store sales increase during its third quarter. Fast-casual restaurants have made customized, locally oriented fare a key selling point.

David Tarantino, analyst at Baird Equity Research, liked some of McDonald’s plans, but worried that the customization and localization efforts will work against intentions to simplify the menu and improve execution.

“While we are optimistic that the planned emphasis on improving operations and reducing menu complexity could help to address recent execution issues,” Tarantino wrote, “we also have some concerns that other plans could re-introduce complexity that might be difficult to manage in a business with such large scale.”

Another concern is costs and the company’s insistence on keeping price increases to a minimum. Commodity costs in the U.S. are running about 3 percent higher this year, Senatore said, due mostly to high beef and cheese prices, yet McDonald’s wants to keep its pricing below the 2.5-percent average for restaurants.

Senatore said that strategy is appropriate because of concerns about the chain’s diminishing value proposition. But, she said, “It will weigh on margins unless and until the improved value brings back traffic.”

There are some things that McDonald’s can hang its hat on, and one of them is its recent “Our Food, Your Questions” marketing campaign designed to increase the transparency surrounding the making of its food. According to the YouGov BrandIndex, that campaign has raised the quality perception and “purchase consideration” of the brand among Millennials, albeit briefly.

The company’s regular dividend should also keep its stock price afloat, despite the sales weakness. Piper Jaffray analyst Nicole Miller Regan wrote that the company’s dividend should equal $3.40 a share. That reflects a 3.7-percent return for its stock, which is much higher than the 1.7-percent median for the companies she covers.

That dividend should keep the stock steady, Barish said, “but we see mostly downside risk to fundamentals with the need to reinvest in growth initiatives making true cost cuts challenging.”

Contact Jonathan Maze at [email protected].
Follow him on Twitter: @jonathanmaze

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