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McDonald’s has been in super-sized trouble for some time. Sales numbers have been falling, attempts at switching things up have failed, and franchises have been expressing doom and gloom. How did it get here, what can be done, and most importantly, what did Thursday’s earnings tell us about the future?
I think several problems were plaguing McDonald’s (NYSE: MCD), but the biggest problem was the rise of the fast-casual concept, in the form of chains like Chipotle Mexican Grill (NYSE: CMG). I think consumers saw that they could get good food that at least had the perception of being more healthy, for only slightly more at the cash register.
That, along with a resurgent Burger King that had successfully turned around its operations, made life difficult for Ronald and Friends.
As a result, the market has changed and McDonald’s somehow needs to figure out how to roll with the time yet still remain familiar to consumers. I always thought a good idea would be to change things up at the menu level, offering variations on themes. Taco Bell seems to do this very successfully. McDonald’s is trying this out, offering things like the buttermilk chicken sandwich and black hamburger buns. Offering breakfast all day is a good move, but it created logistical challenges within the stores.
First Steps of Change
The good news is that third-quarter earnings suggest that these first steps toward a McDonald’s turnaround may be seeing success, although whether it is sustainable or not remains to be seen. Global same store sales were up 4%. Considering that mature fast-food restaurants are happy with 2% increases, this must be a nice surprise.
At first glance, other data isn’t so good, but because McDonald’s has such a huge global presence, it is still getting whacked by the strong dollar. Total revenues were down 5% but increased 7% in constant currency. Total operating income dropped 2% but increased 10% in constant currency. Those are very encouraging numbers.
Net income before income taxes dropped 2%. If you look at the P&L, though, it appears that net income rose by almost $300 million. That’s not really true because you can see there was a change in the income tax expense line that accounts for all of it.
A Systemic Problem?
It’s too early to say things are all fixed at McDonald’s. The turnaround needs a lot more time and I have concerned that the ultimate problem is systemic. We are in a new world and McDonald’s hasn’t truly changed in decades.
If we are talking about a grand makeover to stores and concepts, then that would be one heck of a big cost to the company and to franchises, which already must pay 6% of revenue as royalty fees. Some won’t even want to change since their business, especially out in the rural areas, are probably doing better than urban centers.
That leads to a host of problems, since parent company revenues are also driven by franchise royalties. The parent wants growth because then royalty payments would grow.
McDonald’s isn’t dead, and it has made some good first steps. Will it continue?
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