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Something Has to Change at McDonald’s

Things are going from bad to worse for McDonald's (NYSE: MCD  ) right now. The fast-food titan just posted an almost 2% decline in comparable-store sales in the United States. That was a soggier performance than the 1.4% dip it saw last quarter, and lower still than the 0.7% gain that it managed two quarters ago. Comps took a dive into negative territory last year, and 2014 isn't looking any better so far.

Source: McDonald's financial filings.

The accelerating trend toward shrinking sales is changing the conversation at Big Mac HQ: McDonald's isn't trumpeting plans for strong growth these days, but instead is talking about ending that traffic slide. As the company put it in its quarterly earnings announcement, McDonald's is "focused on stabilizing key priority markets including the U.S., Germany, Australia, and Japan." 

That Mickey D's needs to "stabilize" some of its biggest markets isn't what investors want to hear. 

It was cold last winter
Sure, some of the decline can be pinned on bad weather. Extreme storms and brutally cold temperatures kept many people at home last quarter, giving companies of all stripes an excuse to post weaker results. There was at least one huge exception, though. Chipotle Mexican Grill (NYSE: CMG  ) said last week that winter weather had no negative impact on its business. Yes, traffic was lower on stormy days. But sales sprang back higher in the days following the storms so that total growth remained steady: comps were up a blazing 13.4% overall.

Obviously, McDonald's isn't resonating with consumers in the way that Chipotle is right now. Management seems to get that, which is why the company has named fixing the customer experience as a main focus going forward. CEO Don Thompson summed it up like this in a conference call with analysts: "The key to our growth lies in our ability to place the customer at the center of everything we do." 

The path forward
Breakfast holds the biggest opportunity for early gains, as McDonald's has been a leader in that market for decades. And its strengths in the early morning hours actually match up nicely with Chipotle's advantage at lunchtime: quick service, high-quality ingredients, and strong consumer review scores. So that's a logical place to start looking for a path away from declining customer traffic. McDonald's also has some enormous resources that it can turn to the task. It generated $1.9 billion of operating income just last quarter. That cash can pay for a lot of free coffee.

Source: McDonald's.

But it won't be easy to expand sales, especially with other restaurant chains jumping into the breakfast market. Management admits that results will be "volatile" as it rolls out a bunch of customer-focused initiatives in the months ahead. 

Meanwhile, McDonald's has other levers that it can pull to boost shareholder returns, including refranchising more restaurants. That's the strategy that helped make Wendy's (NASDAQ: WEN  ) one of last year's top performing restaurant stocks. Wendy's sold hundreds of its company-owned restaurants to franchisees, dropping its ownership level from 22% to around 15%. In exchange, it has seen a boost in profitability along with stronger cash flow and a more predictable revenue stream. McDonald's currently owns 19% of its restaurant base, giving it an opportunity to grab some of those same benefits by paring that number down some.

Foolish bottom line
Management says that it will update investors next quarter on its refranchising plans, and on the other major financial initiatives that it's considering with the aim of unlocking value for shareholders. Still, those profit levers won't be much help if they don't come in the context of sales growth. McDonald's needs to find a way to get customer traffic levels back on an upward trend.

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Demitrios Kalogeropoulos

Demitrios covers consumer goods and media companies for, as well as broader moves in the economy.

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