Is McDonald’s Rearranging the Deckchairs on the Titanic?

McDonald’s reimaging efforts may be masking its bigger problems.

Feb 2, 2014 at 8:30AM

Pardon the bombastic headline. McDonald's (NYSE:MCD) is highly unlikely to crash and die financially any time soon if ever. The company's sales, net income, dividend, and share repurchases continue to be nothing short of massive. That being said, the company has been doing a bit of deckchair rearranging that is masking a weakening same-store sales trend that, if not fixed fast, could mean new 52-week lows for the quick-service restaurant.

McDonald's fourth-quarter results
On Jan. 23, McDonald's reported its fourth-quarter results. Revenue increased 2% to $7 billion. Diluted earnings per share inched up 1% to $1.40. Same-store sales slipped 0.1% globally while in the US alone, same-store sales dropped 1.4%.

Take note of the US same-store sales trend. In the third quarter, same-store sales were up 0.7%. For October, they only nudged 0.2%. In November, they fell by 0.8%, and now that we have learned the fourth quarter was hit 1.4% overall, December must have been terrible, relatively speaking, in order to bring the average down for the quarter that far.

But it gets worse
McDonald's reimaged 2,400 of its restaurants in 2012 and 1,529 of its restaurants in 2013 for a total of 3,929.  This total represents around 11.4% of restaurants that have been open for more than a year and are considered part of the same-store sale calculation.

The company says that reimaged restaurants tend to show a 6% to 7% rise in same-store sales the first year. If you do the math and use the midpoint of 6.5%, this means the reimaging contributed more than 0.7% in positive same-store sales. While it doesn't sound like much of a difference, it means the global 0.1% decline was actually a 0.8% decline if not for reimaging. For the US alone, and assuming the reimaging was equally prorated throughout the world, the same-store sales would have declined by 2.3%.  If there was a greater percentage of reimaging in the US specifically than the rate of the rest of the world, then the same-store sales decline in the US alone may have been even worse.

Reimaging is common
It's not to say that reimaging is bad. It does boost sales, at least in the short run, so it would appear to be a wise move. If nothing else, it increases curiosity among consumers or perhaps it makes them feel more comfortable, and they return more often. It's hard to imagine, though, that the average customer just magically one day got fed up with McDonald's décor and growth suddenly halted. More likely, it's been a stale menu and/or failed new introductions and the domino effect of slow or bad service.

For McDonald's shareholders to see meaningful growth again long term, the company needs its customers coming for its menu in addition to the reimaging. Two companies that have been able to demonstrate that doing both together stimulates growth are Burger King Worldwide (NYSE:BKW) and Wendy's (NASDAQ:WEN).

Burger King has been launching successful new menu items such as the Big King and the SATISFIRES. It is also in the process of reimaging its restaurants for which it is targeting 40% of them by 2015. Reimaged stores are seeing a 10% to 15% gain in sales or roughly double the growth rate of McDonald's. Overall, last quarter Burger King reported a 4.9% gain (in constant currency) in same-store sales.

Meanwhile, for Wendy's, the reimage reaction is nothing short of astonishing. Each store reimage has seen a 25% to 35% leap in same-store sales or four to five times the growth rate of McDonald's. While Wendy's only reimaged 200 restaurants last year, it plans to double that pace this year and keep picking up that pace in 2015 and beyond. Wendy's has successfully introduced new menu items that customers love such as pretzel-bun sandwiches.

Foolish final thoughts
The best combination that sparks sales growth in the quick-service restaurant industry is the simultaneous effect of reimage and new menu items that resonate with the customer. Having just one or the other helps, but it isn't enough. If McDonald's can get growth back in its menu again, look for its reimaged restaurant sales in particular to soar.

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Nickey Friedman has no position in any stocks mentioned. The Motley Fool recommends Burger King Worldwide and 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.

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