McDonald's: Bland No More

It would be easy to underestimate the effect that McDonald's (NYSE: MCD  ) has had on our lives. McDonald's invented fast food. (Until they dig up a hamburger near the Pyramids, that is my story, and I'm sticking to it.) McDonald's sold billions and billions of burgers and other foods, which changed the eating habits and even the lifestyle of millions and millions of people.

McDonald's business model has had an impact on many other businesses. Competitor restaurants were not the only businesses to be influenced by the success of McDonald's focus on convenience, speed, and efficiency.

I could stick my neck out further and point out other ways that McDonald's has probably affected our society, but I think you get the point. When McDonald's started, it was one of those rule-breaking companies that David Gardner writes about these days. (Perhaps David wrote his kindergarten thesis on McDonald's.)

I have heard McDonald's commercials criticized for creating a world that never existed (and I am not talking just about McDonaldLand -- or McDonaldBland, to the critics), but it is easy to identify a McDonald's commercial when you see one. How many commercials have you seen that you thought were clever, but later forgot what company or product they were advertising? I bet that never happened to you after watching a McDonald's commercial. Excellence in advertising helped make McDonald's one of the most recognizable brands in the world. I don't think I have ever met a kid who did not love McDonald's, and I am including several over-40 kids in that category.

Dark days
Around the year 2000, it started becoming increasingly clear that McDonald's was losing its grip. Among multiple other problems, customer surveys showed that service and quality were lagging behind rivals. The restaurant had tried new initiatives, such as made-to-order food, that had failed for various reasons. At the same time, competitors, such as Wendy's (NYSE: WEN  ) and Subway, were doing well. Subway breezed by McDonald's in number of U.S. stores shortly thereafter. Wendy's stock return breezed by McDonald's (and McDonald's has not caught up yet). At the end of 2002, McDonald's stock was tanking, and for the first time in its history, the company had a quarterly loss.

I know people who do not like McDonald's and were hoping it would die. The idea did not seem too far-fetched. If you live on the East Coast you might remember a fast food restaurant called Roy Rogers. In its heyday, Roy Rogers had 800 restaurants, a small fraction of the number of restaurants McDonald's has now, but a much larger fraction of the number of restaurants McDonald's had then. I remember when the company names Roy Rogers and McDonald's were used interchangeably in this part of the country to signify fast food, the way the company name Xerox (NYSE: XRX  ) is used to signify photocopying. (Remember the bad jokes about Trigger burgers?)

When was the last time you saw a Roy Rogers? Some still exist. CKE Restaurants (NYSE: CKR  ) , operator of Hardee's restaurants, bought and converted others. But if Roy Rogers could disappear, it is not inconceivable that McDonald's could do the same. The demise of McDonald's would have signaled the passing of an era.

Silver linings
However, the cloud over McDonald's had a few silver linings. While McDonald's had a quarterly loss, cash flow was positive for 2002 and stronger than 2001, which was also cash flow positive. McDonald's had bought Chipotle, among its other holdings. Chipotle seemed to have a lot of promise and could perhaps provide some badly needed growth.

Then McDonald's made what appears to be the best move of all. McDonald's rehired retired international division chief Jim Cantalupo as chairman and chief executive in December 2002. I remember reading an article in Fortune in which Cantalupo said he "gets it," which I took to mean he knew what to do to turn the company around. I remember at the time wondering whether he really did, or whether that was CEO talk.

Apparently, he did get it. Under Cantalupo's guidance, new initiatives -- such as main-course salads -- reignited customer interest. The new "i'm lovin' it" ad campaign also seemed to work.

How long did it take Cantalupo to turn that battleship around? After more than a year of consecutive months of declining same-store sales, in April 2003, just four months after Cantalupo started working again, McDonald's began to pull out of its slump with a string of consecutive months of same-store sales increases. Same-store sales jumped 9.5% in the third quarter of 2003.

At the same time, McDonald's was strengthening its balance sheet by paying off hundreds of millions in debt. The stock price doubled over the middle two quarters of 2003. Whitney Tilson suggested Cantalupo be chosen CEO of the year.

How did Cantalupo do it? A lot has been written about that. I tend to think the real driver was Cantalupo's focus on the customer. "The new boss at McDonald's is the consumer," as he put it.

A return to uncertainty
Tragically, Jim Cantalupo died of a heart attack in April of this year. As if that were not enough, Jim's successor as CEO, Charlie Bell, fell ill with cancer.

Will McDonald's be able to recover from these setbacks? McDonald's stock was selling for close to $30 shortly before Cantalupo's death and is roughly around $28 now. Nonetheless, despite Cantalupo's professed slow-and-steady-wins-the-race policy, McDonald's is still putting up fast-growth numbers. Second-quarter 2004 same-store sales increased 7.8%, the second-highest quarterly increase since 1987.

McDonald's currently seems to be operating on the theory that, to have good ideas, you have to have a lot of ideas. The company is experimenting with Wi-Fi in restaurants, push-button ordering, and new ways of marketing, among other initiatives. This is not your parents' McDonald's.

I believe McDonald's has substantially recovered value from a period in which it was undervalued, and I think it will probably continue to perform well, if not as well as it has over the past five quarters. However, with so many uncertainties hanging over the company and with such a strong recovery already behind it, I would be hesitant to jump in with both feet.

Where do you think McDonald's will be in five years? Tell us what you think on the McDonald's discussion board.

Fool contributor Cass Bielski is partial to the chicken fajita burrito at Chipotle. Feel free to email him. Cass owns shares of McDonald's. The Motley Fool has a disclosure policy.


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