What You Need To Know About McDonald’s Turnaround

The name McDonald’s means one thing to consumers.  That thing is fast food hamburgers.  This iconic brand is among the most well-known American brands to ever be created.  In fact, the name McDonalds conjures up the true American dream in many parts of the world.  There is much truth to this belief as this quintessential burger chain is truly representative of innovation, success, entrepreneurship, and rags to riches story that is truly unsurpassed in the annals of capitalism.

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However, a wrench has been thrown into this long-term success story.  Heavy competition, lack of recent innovation, and slowly changing consumer tastes have cast doubt on the future viability of this hyper-successful, global fast food chain.

The company has responded with an aggressive turnaround plan to counteract the negative sentiment that has started to permeate Wall Street and the minds of consumers.

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Will this multi-level plan work to reset McDonalds as the true king of fast food burgers or will it go down in history as a valiant but failed effort at corporate survival?  Does this mean the company’s time in the sun is over?  That it is time to dump the shares as the one mighty McDonalds fades into obscurity?  Only time will tell for sure, but let’s lay out exactly what’s taking place so a smart investment treatise can be laid out.

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CEO Steve Easterly admits to the lack luster performance by stating, “The reality is, our recent performance has been poor. The numbers don’t lie. Which is why, as we celebrate 60 years of McDonald’s, I will not shy away from resetting this business.”

First, let’s look at the company itself, McDonald’s Corporation operates and franchises McDonald’s restaurants in the United States, Europe, the Asia/Pacific, the Middle East, Africa, Canada, and Latin America. The company’s locations provide a variety of food products, soft drinks, coffee, and other beverages.  According to the most recent official numbers, it ran 36,258 restaurants, including 29,544 franchised restaurants containing 20,774 franchised to conventional franchisees, 5,228 licensed to developmental licensees, and 3,542 licensed to foreign affiliates; and 6,714 company-operated restaurants. The company was founded in 1940 and is based in Oak Brook, Illinois.

Looking at these figures in percentage terms reveals that over 80% of McDonald’s restaurants are franchised. Of the total McDonald’s restaurants worldwide, over 57% are conventional franchisees. In addition, approximately 24% are licensed to foreign affiliates or developmental licensees and only 18% are company-operated.

What is most impressive is that McDonalds feeds nearly 70 million people in over 100 nations on a daily basis.  Talk about scale, market penetration and global brand awareness!!

However, despite these impressive numbers, the company’s sales have been struggling.  In response, McDonalds announced a major restructuring plan.

The major change is to refranchise 3500 stores in a variety of markets.  The refranchising effort will lift the total percentage of franchised units to approximately 90% by 2018.  By doing this, the company plans on achieving the optimal mix in a market by market approach.  Some markets will have 100% franchised units, while other will continue with a mix of corporate and franchised stores.

This effort will provide the company around $300 million in general and administrative savings.  Furthermore, this franchising restructure plan requires less corporate investments and staffing than company owned restaurants.   The effort is expected to result in the lowest expenditures for the company in over five years.

The most interesting and appealing part of the franchising change is that it will enable the local franchisee to determine what the local market needs.  In other words, the local restaurant will be able to offer products that match the demographics of the local customers.

“The power of franchising… is incredibly liberating for us as a McDonald’s system,” McDonald’s CEO Steve Easterbrook said in an investor call about the turnaround plan on Monday. “I have a strong philosophical commitment behind franchising. I think it’s incredibly important to our business.”

This move is not untested in the industry.  It has produced incredible results in the competition.  One example is Burger King.  This competitor wrapped up a refranchising program in early 2014.  The effort resulted in a 99% net income increase with a nearly 100% franchised business model.  In addition, same store sales climbed by 4.6% in the latest quarter.

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Adding to the bullish franchise plan, McDonald’s chief administrative officer Pete Bensen said in a statement, Our new, more heavily-franchised business model will generate more stable and predictable revenue and cash flow streams and will require a less resource-intensive support structure.”.

In addition, Technomic’s VP Dave Henke stated, “Franchisees tend to perform better.” He went on to add,  “They are driven, motivated owners who are more innovative and think outside of the box.” McDonald’s specific numbers in the U.S. last year prove this point. Sales at McDonald’s company-owned stores in the U.S. fell 3.6 percent last year.  By contrast, its franchisee-owned ones suffered a decline of only 0.8 percent.

Now, it is important to note that it hasn’t been smooth sailing for the company’s franchisees.  A recent survey of franchisees revealed they rated the parent company at 1.8 out of a possible 5.  In addition, McDonalds has been named as a party to a variety of labor violations at franchised locations.  However, these are all easily surmountable issues.  With the new control provided to the franchisees, their satisfaction will likely increase along with the individual store profits.

The company also plans on restructuring its divisions into four. The first of the four divisions will be built from strictly the U.S., while the second would include the established markets of Australia, Canada, France, Germany and the U.K.  The third division will focus on high-growth markets such as China, Italy, Poland, Russia, South Korea, Spain, Switzerland and the Netherlands. A fourth division would include all of McDonald’s other markets and would be 100% franchised.

McDonalds also plans to lever up to return between $8 billion and $9 billion to shareholders.  Now, it’s critical to note that credit rating agencies frown upon this move, but it should provide a bump higher for the shares.

When combine one of the most recognized therefore powerful brands on earth, tremendous amounts of capital, a driven and smart CEO, with a long term plan to get back on track, it paints a very appealing picture for investors.

In addition, the fact that McDonalds is part of the Dow Jones Industrial Average means every DJIA index fund needs to own shares.  In other words, there is tremendous institutional interest in the company for this very fact, let alone it’s a major American firm.

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Not to mention solid dividend growth over the years makes the company a very nice investment for income investors.

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Action to Take:

Shares have just slipped below the 50 day simple moving average and are solidly above the critical 200 day simple moving average.  Buy now in the $96.30 per share zone with a $109.00 per share target price.  Initial stops are suggested just below the 200 day SMA at $93.27 per share.