MCD: McDonald’s Needs to Put the Brakes on its Growth Plans

Though MCD stock is cheap, it will continue to give investors indigestion

The first thing that Steve Easterbrook, chief brand officer at McDonald’s Corporation (NYSE:MCD), needs to do when he takes over as the head of the iconic burger chain on March 1 is to slow down the company’s plans to open 1,000 new restaurants. He may even need to shut some poorly performing restautants.

mcdonald's-mcd-stock ko stock yum stockAfter opening 1,300 new restaurants last year, Ronald McDonald’s corporate parent has scaled back its 2015 expansion to 1,000 new eateries, but even that figure seems too high given the chain’s lackluster financial performance — especially five consecutive quarters of flat or declining same-store sales.

Indeed, many of McDonald’s better-performing rivals, including Burger King Worldwide Inc (NYSE:BKW), Wendys Co (NASDAQ:WEN) and Chipolte Mexican Grill, Inc. (NYSE:CMG) are opening far fewer new locations.

Starbucks Corporation (NASDAQ:SBUX) has more ambitious opening plans that MCD, adding 1,600 new shops, but its financial performance is far superior than the home of the Golden Arches.

Burger King, for example, expects to open about 150 new locations this year while Wendy’s expected to open 15 new company restaurants and 45 new franchise restaurants last year. Chipolte, which recently disappointed Wall Street, plans to open about 200 restaurants.

Until the chain announces plans to scale back its planned store openings or close underperforming locations, investors should stay away from MCD stock. I know it pays a fat dividend yielding 3.6%, generates a ton of cash flow and boasts a cheap price-to-earnings multiple of around 20. MCD stock just isn’t worth the risk.

MCD’s business model is broken and the fixes that are going to be required to right the company’s financial ship aren’t going to be easy given the huge competitive headwinds the chain faces. It just makes sense for MCD to either pull back from its ambitious openings plans or to pull the plug on franchises that aren’t cutting it financially.

Otherwise, it risks falling into Albert Einstein’s classic definition of insanity — repeating the same actions and expecting a different result.

A few years ago, Starbucks under went a similar retrenchment and closed down 600 stores. CEO Howard Schultz tinkered with the coffee chain’s business model, improved its food offerings and decided to add new products, such as tea. The result was an epic turnaround, with SBUX shares gaining more than 300% over the past five years.

However, the challenges facing MCD cannot be underestimated.

MCD has let the quality of its food slip in recent years. Study after study have noted that consumers remain eager to chow down on burgers, as the recent monstrous Shake Shack Inc (NYSE:SHACK) IPO indicates. They just don’t like MCD.

Millennials, in particular, have little connection to the brand. They want their money at so-called better burger chains such as Smashburger Master LLC and at chains they perceive as healthier such as Chipolte. Never mind that Chipolte’s food is just as fattening if not more so than McDonald’s.

McDonald’s takes pride in the profitability of its franchisees who own the vast majority of the 36,000 restaurants that operate under the Home of the Golden Arches. They generate about $2.5 million in annual sales, more than twice the average take of the average Burger King and $1 million more than the average Wendy’s. These independent business owners, though, are furious with the Oakbrook, Ill-based company since their costs have been soaring in recent years as their profits withered.

Part of the problem is that McDonald’s has loaded its menu up with poorly selling items that has created huge customer service problems. QSR magazine, a trade publication, noted that McDonald’s recorded its slowest average service speed since the magazine began tracking drive-up service.

Slowing down its store opening plans and shutting some locations is a needed first step for the company to become more nimbler. Until then, investors should avoid MCD stock.

As of this writing, Jonathan Berr did not own shares in any of the aforementioned securities.

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