Morningstars Fair Value Estimat: 102 USD
Investeringsanalyse, R.J. Hottovy, 05-05-2015
After an impressive eight-year run from 2004 to 2011 highlighted by average annual global comparable sales growth of 5.6% and roughly 1,500 basis points of operating margin expansion to north of 31%, McDonald's fundamentals have weakened in recent years amid increased competition, self-inflicted product pipeline and marketing issues, a tepid macro environment, and slow reaction to evolving consumer preferences.
To confront these issues, new CEO Steve Easterbrook has introduced a four-pillar approach to operational improvements emphasizing organizational accountability, customer centricity, "progress over perfection," and process simplification. On May 4, the company unveiled the initial steps of its turnaround plan, including reorganizing the company into four segments based on the maturity and competitive position of its different markets, refranchising 3,500 locations by the end of 2018 (targeting franchisee system ownership of 90%), and $300 million in net annual SG&A reductions. While discussed in less detail, it also appears that McDonald's remains committed to a more streamlined menu (but one still allowing for personalization), decisions made closer to the customer at the local and regional level, consumer-facing technologies, and improved agility across all business functions. In our view, each of these priorities is important, as they can all help McDonald's align itself with evolving consumer restaurant preferences and rebuild pricing power over time.
That said, while we view elements of McDonald's turnaround as practical and should help to improve the business over a longer horizon, we do not expect the market to buy into the turnaround without greater color regarding menu innovations, restaurant-level efficiency, supply chain improvements, and capital structure optimization. We also believe a turnaround will not take place overnight; instead, we believe a McDonald's overhaul will be a multiyear process. However, assuming it can get more out of its brand, franchisee, and scale advantages, we believe McDonald's can gradually return to low-to-mid-single-digit system sales growth and mid-single-digit operating income growth.
Bulls and bears say
Bulls say
- We believe CEO Steve Easterbrook has developed several practical first steps for a turnaround, including refranchising 3,500 locations by the end of 2018 and $300 million in net annual SG&A reductions.
- By 2015, management believes franchisees can account for 20%-25% of China restaurants compared with 15% in 2013. We believe this will help bring APMEA margins closer to other divisions and supports our longer-term margin outlook.
- With a dividend yielding more than 3%, McDonald's is suitable for income investors looking for more exposure to an expanding global middle class, in our view.
Bears say
- The global QSR industry is fiercely competitive, marked by a history of price wars. The explosive growth of the fast-casual category could make it more difficult for McDonald's to stand out among more affluent and millennial audiences.
- Food commodity price volatility, labor cost inflation, and foreign currency movements could disrupt McDonald's quarter-to-quarter results.
- Bankruptcies among quick-service franchisees increase during recessions. High food, energy, and labor costs are a concern, and tighter credit markets could constrain growth among smaller franchisees.
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