Comedian/writer/director Paul Feig wrote a hilarious story called The Big Red Shoe Diaries, which I saw him read live many years ago. It’s a comedy that will have you rolling on the floor, because what’s more amusing than hearing a story about a guy who played Ronald McDonald as a teenager?
Besides, McDonald’s (MCD) investors could use something to laugh about lately, considering that the chain is really struggling.
To understand what’s going on with McDonald’s stock, you have to know about how the company handles franchises. This is relevant because when you see McDonald’s second-quarter earnings report, you’ll view the number through that prism.
McDonald’s Franchises: Hardly a Happy Meal
I have cousins that own franchises, and one of them is a hardcore businessman. McDonald’s Corporation will frequently send out suggested or required changes and “improvements,” which are often extremely expensive. It might be something like a whole new grilling apparatus, or an exhaust system. They can cost a fortune.
As my cousin tells it, he pushes back at McDonald’s and tells them, “Who are you to come into my store telling me what to do with my capital?”
Fireworks ensue.
Apparently, as a franchisee, that’s how you have to behave to keep from losing tons of money on useless upgrades. It costs more than $2 million to buy a store, and that means taking on debt. MCD is making things worse by insisting on crazy promotions that impact the bottom line negatively. New products slow service down, and customers aren’t at MCD for slow service.
Now, with that in mind, look at the McDonald’s earnings report.
McDonald’s Earnings
A couple things right off the bat: McDonald’s global comparable-store sales fell 0.7%, hurt in large part by U.S. comps, which declined 2%. That means MCD franchises are seeing fewer dollars spent in their stores. Yes, 0.7% isn’t a lot, but it adds up over time.
It also tells us that all these promotions and new products aren’t working.
McDonald’s is testing an all-day breakfast plan which, I have to admit, should work. I know a lot of people who get awfully upset and change into their ultimate form when they can’t get their Egg McMuffin at 10:31 a.m.
These lower comps for McDonald’s stock led to a 1% decline in constant currency revenues, but a 10% decline when factoring in currency issues. Those percentages are also reflected in earnings per share — again, down 1% in constant currency and 10% because of the strong dollar. All told, we’re looking at a 6% decline in operating income for MCD.
The Asian region isn’t loving McDonald’s, either, with comps down 4.5% and operating income down (ouch) 16% in constant currency and 26% because of the dollar.
Net income fell from $1.387 billion to $1.202 billion, or 13%, not normalized for currency.
Perhaps the only good news was a couple of narrow beats. Adjusted earnings of $1.26 per share, while lower than the $1.40 earned in the year-ago period, did beat Street estimates by 3 cents. Revenues of $6.5 billion also were off, by more than 9%, but just edged expectations for $6.45 billion.
But frankly, I’m not seeing much here that gets me excited about the prospects for McDonald’s stock.
Bottom Line
Now, read this very important paragraph from McDonald’s CEO Steve Easterbrook, and tell me how you would feel if you were running a franchise:
“We begin third quarter under a new structure supported by market-level focus, stronger accountability and an unwavering emphasis on the basic fundamentals of running great restaurants. We are aligning our initiatives and resources behind longer-term strategic actions with the ability to drive meaningful improvements in our business. We have talented franchisees, suppliers and employees working together to create the change needed to deliver a better experience for our customers.”
Sure, it sounds optimistic. But if I was critically thinking about it, I’d be thinking, “Whaaaaaaat? That’s corporate gobbledygook! Where’s the vision for what McDonald’s will become? Where’s the specific, actionable things that the company is doing for us?”
Even my teenage daughter noticed that Yum Brands’ (YUM) Taco Bell is constantly changing its products, yet keeping a basic menu. Why can they do that while MCD flails like Paul Feig running for his car from a group of screaming children?
McDonald’s stock is up 0.5% in Thursday’s midday trading, so I guess you can’t keep a good clown down forever.
But the only attractive thing about MCD right now is its dividend — and you can find 3%-plus yields with far better growth prospects.
Lawrence Meyers is the CEO of PDL Capital, a specialty lender focusing on consumer finance. As of this writing, he did not hold a position in any of the aforementioned securities. He has 20 years’ experience in the stock market, and has written more than 1,200 articles on investing. He also is the Manager of the forthcoming Liberty Portfolio. Lawrence Meyers can be reached at TheLibertyPortfolio@gmail.com.
