We already know McDonald’s (MCD) stock has been struggling. But McDonald’s earnings report Thursday may suggest that the turnaround that has been in place for a few months may just be bearing fruit.
But McDonald’s will have to do even more to complete its turnaround, which is easier said than done.
Let’s examine the numbers and divine what we can from them.
Breaking Down McDonald’s Earnings
The most important number to me for McDonald’s earnings was global comparable store sales, which increased 4%. After several depressing quarters, a 4% increase is not only welcome, but much better than the 2% most people might be happy with.
Now, we have to be careful looking at everything else, because the foreign exchange headwinds skew everything. Consolidated revenues fell 5% but were up 7% in constant currency. That’s great news, as was the fact that consolidated operating income fell 2% but was up 10% in constant currency.
Don’t be fooled by the net income increase of 23% to $1.309 billion, though; almost all of that was due to a foreign income tax quirk. Earnings before income taxes actually fell by 2%.
We need to let the turnaround play out a little more, but so far what I’m seeing is that management may be providing the kind of vision necessary for a change. Still, I think the problem is systemic.
McDonald’s has existed for decades without any real new competition. The turnaround and resurgence of Restaurant Brands International’s (QSR) Burger King was just one facet of a multilayered problem MCD has to face.
The new problem for MCD stock arrived in the form of fast-casual dining, of which Chipotle Mexican Grill (CMG) is very much the face of. Whereas MCD used to be one of a few fast-food default choices for people of all income levels, the fast-casual chain has siphoned off the middle and upper class consumers by providing superior food at very reasonable price points.
It’s tempting to remain with tradition, but the truth is that the fast-food market has changed. McDonald’s must change with it, or MCD stock and investors will pay the price. I am pleased to see that MCD is putting out new products by putting spins on core products, much in the way that Jack in the Box (JACK) and Yum! Brands’ (YUM) Taco Bell have done, and that can only help MCD stock.
What MCD Stock Needs
What the numbers tell us, however, is that this change probably has to be more profound. That does not mean making these few menu changes, or offering all-day breakfast. I’m concerned that it may require a complete rethinking of McDonald’s, yet somehow still maintaining its familiar image. It can’t look like it’s trying to hard.
This is a very fine line to tread and it will really take a visionary CEO and marketing team to make it happen. Steve Easterbrook may or may not be the guy.
What concerns me is that such a huge change means massive capex expenditures for franchises as well as logistical nightmares. It’s been a logistical nightmare as it is to offer all-day breakfast. It isn’t as simple as “just do it.” It means having all those additional ingredients ready and on hand with staff that is trained to make those products. Can you imagine how difficult it would be to integrate a complete overhaul?
Certainly any such initiative would have to be piloted using company stores. Franchises are already saddled with royalty payments and often forced to make expensive equipment upgrades. Then there’s the problem that not all franchises are struggling. Some are doing just fine, and won’t to fix what isn’t broke. Note that revenues from franchised restaurants only fell 5%, vs. 10% at company-owned stores. So any such fantastical transition would have to be optional for franchises.
Of course, that creates other problems for MCD stock, because company revenues at the parent-level depend on royalty payments from the franchises. The parent wants to see growth because that means royalty payments would grow and so would net income. If some franchises shrug off these changes, happy with stability or slow growth, that doesn’t help MCD stock as much.
In other words, we have a difficult situation here with no clear solution. What we know is that something must be done. The company has made the first small steps, and investors seem relieved since MCD stock shot up 8% Thursday.
Only time will tell.
As of this writing, Lawrence Meyers did not hold a position in any of the aforementioned securities.
