How McDonald's Can Get its Groove Back

This fast-food giant will get its groove back, and become a "buy," if it delivers one thing on this weeks earnings call.

Jan 22, 2014 at 5:30PM

After McDonald's (NYSE:MCD) ho-hum third-quarter earnings spooked investors, I found myself wondering: what can "fix" this fast-food giant? After much thinking, I'd like to share a simple way that I believe this chain can get its groove back. 

McDonald's reports fourth-quarter earnings this week and, obviously, we can't change its performance for the previous three months. In fact, considering "underdog" competitor Wendy's (NASDAQ:WEN) just reported a decent quarter, McDonald's might sell-off simply for not measuring up.

However, I think this stock could become a "buy" if you hear one vital thing on this weeks earnings call.

McDonald's needs to focus
Changing consumer tastes, as well as the pressure to grow (despite already being gigantic), have caused McDonald's to lose its focus. It's a classic and common mistake to try and be "all things to all people;" but it is still a mistake. Starbucks may do a wonderful job of whipping up premium coffee, and Buffalo Wild Wings may drive you wild for their wings, but it's unlikely that McDonald's can do both things well. So why is it trying?

With the "mighty wings" fiasco in the rearview, we need to know, why McDonald's is trying so hard to expand its palate?

McDonald's needs a clearer menu--and brand
If McDonald's needs an example of why focus is important, it need only look at Wendy's most recent quarter. While McDonald's has been focusing on growing its menu, and international store count, Wendy's pulled in the reigns this past year to focus on quality. The company launched a successful campaign to upgrade the look of its stores to a more "up-scale" variety, and it also introduced higher-end items such as pretzel-bun sandwiches. By skipping the international expansion and focusing on quality, Wendy's carved a niche that I (frankly) wasn't sure it could. The short-term results have been positive; Wendy's raised guidance, as company owned comps were up 3.1%, and total same-store sales rose 1.9%

I'm not recommending Wendy's at this point, nor am I saying McDonald's should go "high-end," but I do think McDonald's needs to give customer's a clearer reason to show up. 

Wendy's is telling people to go to their restaurants for a higher-end experience, and premium burgers. Whether this plan works long-term remains to be seen, but  at least it is a clear strategy. McDonald's needs to "tell" customers what they should go to McDonald's, other than: "it's cheap."

The golden arches needs to follow the "golden rule"
The most basic "golden rule" of the restaurant business is to have as concise a menu as possible, and McDonald's is violating it. While this causes brand confusion, it also doesn't make financial sense. Here's why.

1. Having too many menu items that don't use similar ingredients (such as a yogurt parfaits and hot wings), raises inventory costs dramatically. 

2. When sales don't meet estimates, restaurants with crowded menu's suffer "losses" because their un-used inventory spoils. Restaurant inventory is perishable, so it makes better business sense to have items that "rhyme" and use similar ingredients. 

Not to pile onto the mighty wings blunder, but it serves as a perfect example. In the end McDonald's was left with 10 million pounds of un-sold chicken. Because McDonald's shoulders costs like this, it is not able to serve fresher products (that may go bad more quickly). 

McDonald's management team is smart. They were wise enough to realize they low-calorie menu items to adapt to a changing consumer. So they must know that the biggest struggle for McDonald's is trying to balance a "value-priced" brand, with an image of higher quality.

By focusing the menu on less items, McDonald's can save inventory costs and improve quality (ever so slightly). In essence, the focus will help them marry that concept of value-pricing, and better quality ingredients for their guests.

Finding value in arches
McDonald's beat EPS expectations on its most recent quarter, but the slow growth left investors worried. If another tepid quarter sends the stock downward, it could become a "buy" with one simple key.

CEO Don Thompson needs to explain a plan to condense the menu (slightly). If the chain can do that, and keep a "healthier bent" while refocusing the menu, I think it could be bought. McDonald's doesn't need to change radically, this step should be enough to get its groove back.

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Adem Tahiri has no position in any stocks mentioned. The Motley Fool recommends McDonald's. The Motley Fool owns shares of McDonald's. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

4 in 5 Americans Are Ignoring Buffett's Warning

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Jun 12, 2015 at 5:01PM

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David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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