International restaurants like this one in France are increasingly tapped for testing new technology. Image courtesy of "bizmac" under Creative Commons license.
McDonald's Corporation's (MCD -0.42%) second-quarter 2015 earnings, reported late last month, underscored the difficulties the world's largest quick-service restaurant operator faces in effecting a turnaround. Revenue declined 10%, a drop exacerbated by foreign currency effects. The company took a $45 million charge related to the restructuring of its global geographical business segments, which contributed to a 16% decrease in operating income.
During their earnings call with analysts, executives highlighted both MCD's progress and the thorny challenges the company is grappling with in trying to return to credible revenue and earnings growth. Below, we review and analyze five of the most important points that management made during this post-earnings-release call on July 23rd.
1) Global comparative sales will soon turn positive
Looking ahead to the third quarter, we expect positive global comparable sales led by growth in our newly created international lead market segment and China's continuing recovery in the 2014 APMEA supplier issue. -- McDonald's CEO Steve Easterbrook
CEO Steve Easterbrook's announcement that the company would book positive global comparative sales next quarter has provided some support to MCD's stock in the weeks since second-quarter earnings were posted. In the last seven business quarters, McDonald's has recorded only one global comparable-stores sales increase (versus the prior year quarter) -- a paltry 0.5% rise in Q1 2014.
The international lead market segment that Easterbrook refers to above contains five countries that McDonald's has identified as similar in economic dynamics and growth opportunity: Australia, Canada, France, Germany, and the United Kingdom. This segment, according to the company, produces about 40% of McDonald's total annual operating income.
Anticipated strength in these markets, coupled with a gradual recovery in China -- which has been placed in the new "High-Growth Markets" segment -- paints a picture of a rekindled international business. Yet it's important to note that McDonald's is now "lapping" previous disappointing performance from the prior year.
In the third quarter of 2014, the company reported a global comparable-sales decrease of 3.3%. Thus, it won't be a huge feat for those comparable sales to turn positive in Q3 2015 -- investors should instead pay attention to the size of the positive change when figures are released in October.
2) U.S. business is going to be a long-term project
No one move will turn a business that's been in decline for nearly three years, and more recovery will be bumpy. -- CEO Steve Easterbrook
When discussing revenue during the earnings call, Easterbrook acknowledged that there is "no silver bullet" to quickly change the fortunes of the company's U.S. business. The U.S. alone is equal to the international lead segment in that it also accounts for 40% of McDonald's total annual operating income.
The company is throwing a number of incremental initiatives at domestic sales, including the testing of all-day breakfast for a possible nationwide rollout this fall, menu simplification, and development of a mobile ordering app. McDonald's executives have done well to acknowledge what many of the company's critics have long pointed out: that the problems in the U.S. won't be solved overnight.
By lowering expectations for a quick fix, the management team is subtly communicating a goal of stabilization before growth. What would stabilization look like? It would first mean bringing the comparable-sales decreases for each quarter from a 2%-3% range to near breakeven -- somewhere between a positive or negative 1% change on a consistent basis.
The company's best hope may be to gain a tiny bit of traction from each of the numerous initiatives it's launched, and then invest with conviction in marketing once comparable revenues have stabilized. This is a strategy that Coca-Cola, under a recent business narrative not unlike McDonald's, has begun to employ with a small measure of success.
3) The dividend policy will change this year
As we execute the initial steps of our turnaround plan, we are actively evaluating our capital allocation decisions, including our dividend as part of our broader strategic planning process. -- CFO Kevin Ozan
CFO Kevin Ozan's comment above in his prepared remarks was easily the most intriguing quote of the conference call. Part of McDonald's turnaround strategy can be charitably described as shareholder appeasement, in that the company aims to return the mammoth amount of $18 billion-$20 billion to investors over a three-year period that runs through the end of 2016.
Year to date, McDonald's has returned almost $4 billion to shareholders through dividends and share repurchases, and is well on its way to 2015's goal of an $8 million-$9 million total cash return. But the company is also pushing out its annual dividend announcement, which typically takes place in September, to November.
Management explained that it's looking very carefully at the company's capital allocation structure going forward, but when pressed during the conference call, CFO Ozan did not indicate management's bias either way. It's possible that McDonald's may weaken one of the pillars of its stock price for the last several years, and perhaps lower the rate of increase in the company's dividend, or simply keep the dividend flat. McDonald's has increased its dividend every year since first offering one in 1976, and the stock currently yields an enticing 3.5%.
Perhaps executives recognize the merit of being more conservative with share repurchases and dividend payments, and instead, using some of these funds to support franchisee investments in "Create Your Taste" customized self-ordering, and other technology innovations corporate wants to accelerate. The suspense of McDonald's capital allocation decisions will only build until November.
4) We're taking care not to crowd the menu, again
With regards to, if you like, new product development, I would say, at a national level, we will be looking at, if you like, quality over quantity. It's not about having lots of national LTOs, because that does complicate the business. It gets confusing to message right. -- CEO Steve Easterbrook
In the comments above, Easterbrook sought to assuage investor concerns that McDonald's will needlessly complicate its menu, after initial efforts to bring the crowded array of choices on typical U.S. menus under control. "National LTOs," or limited time offers, often bring a temporary boost in sales to franchisees, but they can be fraught with difficulty, as well.
Former McDonald's CEO Donald Thompson experienced this first hand when the nationwide introduction of "Mighty Wings" failed to inspire customers, and left the company with 10 million pounds of frozen wing inventory at the end of 2013, which it had to sell at a steep discount to get rid of.
The current management team is aware of such risks, and moreover, appears willing to give streamlined menus, especially at U.S. drive-throughs, the college try, to entice customers to return to McDonald's during its most profitable dayparts.
5) Specific countries are already proving our technology model
If you go to France, the advancements they have made with technology, for example, on how they have totally reappraised the customer journey, is fantastic to see. -- CEO Steve Easterbrook
An interesting phenomenon has occurred during the past couple of years. While much of McDonald's research and development and technology decision making still originates in the U.S., it's no longer the primary market for adoption of new technology. After the comments above, Easterbrook went on to point out that all French restaurants now have self-order kiosks, a feature which is still being test marketed in different forms here in the U.S.
Easterbrook also disclosed that Australia is the lead market for McDonald's "Create Your Taste" order customization platform. Australia's status as an innovation market in the McDonald's system has been apparent for some time. The land down under has already launched its own mobile ordering app, "mymacca's" -- and we can be fairly confident that McDonald's is incorporating lessons learned from mymacca's into its app development stateside.
That other developed countries should lead McDonald's technological evolution evidences the company's bent to become a more nimble and competitive quick-service operator. This makes sense, as the sprawling U.S. market dwarfs all other country-specific markets.
Upending the decades-long practice of testing new technology interminably in the U.S. is a smart way for McDonald's to quicken its technology-innovation cycle. After all, McDonald's is the quintessential global business, and recovery will have to come from each and every corner of the globe.
