MCD – The Journey of 1,000 Miles Begins with a Single Step
McDonald’s (MCD) has had a difficult two (plus) year period, and the CEO during that period (Don Thompson) will not be part of any potential recovery as he was replaced last night by the company’s Chief Brand Officer, Steve Easterbrook. While MCD unquestionably faces some secular issues related to the quality of its product offering, supplier issues in China and recently in Japan strike at what the company has long viewed as a competitive advantage – its supply chain. Mr. Easterbrook clearly has a job of work ahead of him, but we continue to believe that, at current levels, with a nearly 4% dividend yield, the risk/reward for patient investors is favorable based on our view that global brands, even tarnished ones, with robust FCF, represent optionality with at least some chance of renewed success.
Mr. Easterbrook is certainly qualified, having managed businesses within MCD as well as for other organizations, but the fact that change has begun is the more important signal for investors.
Having said that, MCD is in need of much more than cosmetic fixes such as menu tweaks and slightly shorter wait times for customers. At its core, MCD is built on a global supply chain that is more 1990’s than it is 2010s – a source of cost savings geared toward delivering frozen product at a cost advantage versus its peers. Consumer tastes have shifted, with people demanding fresh ingredients and better for you, even in the case of simple indulgences such as burgers. Absent a product offering that resonates with that consumer profile, the company has been largely reliant upon discounting, with the Dollar Menu seemingly a preferred strategy of Mr. Thompson over the past two years.
Simply put, MCD needs to be substantially rebuilt. The cost of such a rebuild can be funded “internally” to some degree as the company’s SG&A structure could serve as a source of funds. The company needs to step back from its race to the bottom strategy of offering lower quality food at lower prices. It certainly won’t happen overnight and may not happen at all, but in our conversations with investors, MCD has been left for dead, almost completely. That fact alone intrigues us, and we think last night’s move by the company is an acknowledgement that change is necessary. We believe that fundamental change is necessary, and will look to Mr. Easterbrook’s actions to see if he agrees.
In what looks to be a smart move, the company added Margo Georgiadis, formerly of Google, to the Board of Directors. In addition to a multitude of other sins, MCD has fallen behind competitors such as Starbucks (SBUX) with respect to the company’s digital engagement with consumers. Simply put, management needed some tech experience and seems to have gotten it.
Bottom line, our constructive view of MCD is one that is rooted in the optionality associated with a still robust (if not thriving) global brand and associated free cash flow. A turnaround won’t be quick and won’t be easy, but it appears to us that the pendulum may have swung too far toward “impossible” for some investors.