By: Jason Dalavagas
The business outlook at McDonald’s (MCD) is mixed. The company finished 2014 with lower sales and earnings compared to the prior year, as it continued to struggle with a strong U.S. dollar, fierce competition, and weakness in certain European markets. CEO Don Thompson was replaced by company veteran Steve Easterbrook on March 1, and this has given investors some hope that change is on its way. Indeed, Easterbrook has just unveiled a new global turnaround plan centered on driving operations, returning excitement to the brand, and unlocking financial value. Nevertheless, these initiatives will probably need time to take hold.
Investors interested in the stock will see that its price has remained in a relatively stable range over the past three years or so. Unfortunately, we don’t envision much improvement in the near term. With sales and earnings likely to come in lower than that of 2014, the stock price will likely remain in the $90-$100 range over the next six to 12 months. The equity is a safe pick, however, with a Safety rank of 1 (Highest) and an A++ Financial Strength rating. MCD also offers a dividend yield well above the Value Line median.
The question is how long it will take for the company’s turnaround efforts to take hold and for sales and earnings to return to growth. Likewise, is this stock a good pick over the long term? We will address these issues by performing an easy-to-follow SWOT analysis of the company, evaluating its Strengths, Weaknesses, Opportunities, and Threats.
The Business
McDonald’s operates and franchises McDonald’s restaurants, which serve a locally-relevant menu of food and drinks at affordable prices. As of the end of 2014, it had 36,528 restaurants in 119 countries. Primary products include the Big Mac, Quarter Pounder, Chicken McNuggets, and McFlurry desserts. Many stores also offer breakfast menus featuring the Egg McMuffin and McGriddles. McDonald’s purchases food, packaging, and equipment from numerous independent suppliers. Franchised restaurants must adhere to standards and policies that will protect the brand.
In 2014, about 81% of McDonald’s restaurants were owned and operated by independent franchises. The company typically owns the land and building, or secures a long-term lease for the restaurant location, with the franchisee paying for equipment, signs, seating, and décor. The franchisee also pays a royalty based upon a percent of sales, along with rent. This allows the company to generate significant levels of cash flows. McDonald’s was founded in 1940 and is headquartered in Oak Brook, Illinois and had 420,000 employees at the end of last year.
Strengths
Strong Global Brand: McDonald’s has one of the most recognizable brands in the world. Most individuals in the United States, and much of the world, instantly recognize the company’s “Golden Arches”. The company provides consistency in its food, so that you can get the same taste whether you’re eating a Big Mac in New York or Moscow. However, it also provides cultural diversity in the foods it offers based on the location of the restaurant, thereby adding to supplemental sales in each particular region. The company’s success has allowed it to become the world’s largest fast food restaurant chain in the world.
Diversified Income: Since the company is so large, with so many locations around the world, its total sales and earnings in different regions tend to offset one another. It has locations in nearly 120 countries, so if domestic sales are slumping, it’s possible that they could be strong in South America or Europe. As a result, the company doesn’t rely on one key source of income, unlike many of its rivals. For example, Burger King (BKW) relies almost exclusively, roughly 98%, on the United States for its earnings. This diversification allows McDonald’s to have relatively stable cash flows, and generate consistent profitability.
Weaknesses
Negative publicity: McDonald’s has always maintained the perception that its food is unhealthy, loaded with fat, carbs, salt, and sugar. Well, these perceptions are generally on point, as most items on its standard menu are relatively unhealthy. The chain has been widely criticized for promoting unhealthy eating habits, leading many of its customers to put on pounds. 2004’s documentary, “Super Size Me”, didn’t help the company, as it documented Morgan Spurlock’s rapidly deteriorating health as he ate only McDonald’s for a 30-day period. As a result, many health conscious consumers don’t even consider having a meal at McDonald’s, despite its efforts to introduce healthier options.
High Employee Turnover: Most jobs at McDonald’s are low skilled and low paying. As a result, there is a significant amount of employee turnover. Many employees don’t take the job seriously, or only do it for short periods of time, and this leads to lower performance. Since there is so much turnover, training costs are high, pressuring the company’s bottom line.
Opportunities
Upgraded Menu: New CEO Steve Easterbrook has big plans to turn the company around. Part of the plan is to offer premium products at some of its locations. The restaurant recently introduced artisan chicken and sirloin burgers to its menu in parts of the U.S. The company is also trying to strengthen its position in the high-margined caffeinated beverages industry, dominated by Starbucks (SBUX). McCafe has had some success by keeping prices competitive, and the company has been able to harness its vast store network, marketing muscle, and highly efficient supply chain. The McCafe menu also now includes fruit smoothies, an appeal to more health conscious consumers.
Expansion Plans: McDonald’s is always on the lookout to expand its market share. While the markets in North America and Europe are fairly saturated, there are opportunities in more underdeveloped nations. The company also recently announced that it was going to refranchise 3,500 restaurants by the end of 2018, accelerating the pace of refranchising and increasing the global franchised percentage from the current 81% to 90%. This should allow for a more streamlined, lower cost, and more stable organization.
Threats
Competition: McDonald’s faces significant competition from national, international, regional, and local retailers of food products. It competes on the basis of price, convenience, service, menu variety, and product quality. While it does a good job on most of these metrics, product quality is something that management is working on, given consumers’ increasing preference for quality and natural products. In the hamburger fast food category, McDonald’s primarily competes with Burger King and Wendy’s (WEN). However, it still has the highest market share in the overall fast food market, with a 22% share, ahead of competitors Yum! Brands (YUM) and Subway.
More Health-Conscious Customers: Many consumers, both in the U.S. and abroad, are trying to eat a healthier diet. The rise in popularity of organic products, fresh fruit and vegetables, and goods with all-natural ingredients is somewhat of a concern for McDonald’s. While the company has very strict quality controls for its food, customers aren’t exactly going to McDonald’s for free-range chicken and organic vegetables. The company is also facing concerns that younger, more health-conscious consumers, will hurt results in the long run unless a shift in strategy is made.
Conclusion
McDonald’s remains the world’s leading global food service retailer, and posts big profits each year. However, as we mentioned above, there are some concerns. The company continues to face fierce competition, and faces a challenging subset of the population that is focused on healthy eating. A new CEO and strategy should help to provide more stability at the company, but this will likely take some time to materialize. As a result, we don’t think the stock is a good choice at the moment for short-term investors, but assuming the success of its global initiatives, there could be some appeal for longer-term investors.
