McDonald's (NYSE:MCD) and Wal-Mart (NYSE:WMT), the undisputed leaders in their industries, have undergone notable turnaround efforts in the past few years after both companies came under the new leadership of Steve Easterbrook and Doug McMillon, respectively.
In this episode of Industry Focus: Consumer Goods, Motley Fool analysts Vincent Shen and Sarah Priestley look at their paths to the CEO office and their respective visions for each company, including new initiatives, early results, and the challenges that remain.
A full transcript follows the video.
This podcast was recorded on Aug. 30, 2016.
Vincent Shen: This episode of Industry Focus is brought to you by Rocket Mortgage by Quicken Loans. Rocket Mortgage brings the mortgage process into the 21st century with a fast, easy, and completely online process. Check out Rocket Mortgage today at quickenloans.com/fool.
Welcome, Fools, to the latest episode of Industry Focus, the podcast that dives into a different sector of the stock market every day. I'm your host, Vincent Shen. It is Tuesday, Aug. 30, and today, I have the great pleasure of introducing Sarah Priestley, who's making her Industry Focus debut -- kind of -- at least, for the Consumer Goods sector. I know you've been on the show with Dylan for Tech a few times. How are you doing, Sarah?
Sarah Priestley: I'm good! Thank you very much for having me.
Shen: Are you excited?
Priestley: Yeah, very excited. This is interesting for me, very interesting -- not, obviously, that tech isn't. Hopefully Dylan won't listen to this podcast. (laughs)
Shen: So, we have a great discussion for you today. But I wanted to mention that Sarah and I are pretty excited that, at this moment, there's about 36 hours remaining to the month of August, because we've been suffering through the past 30 days, after we decided to try to kick sugar along with a few other Fools here at HQ. Basically, the rule was no added sugar. Things like fruit are fine, but the good stuff, things like ice cream, chocolate, are no-go. And you can't forget that a lot of savory foods, too, like pasta and bread, I've been missing pizza a lot, even ketchup has added sugar too. So, Sarah, I have to ask you, what has been the toughest thing for you to avoid in August, in terms of sweets?
Priestley: Chocolate. Chocolate has been missing from my life.
Shen: That's a very common answer among the people who are participating, as something that's hard. I have to say, when the clock strikes midnight tomorrow, what's the first thing you think you're going to be eating, if you're up at that time?
Priestley: My parents came a few weeks ago, and they brought some British confectionery, which I'm very partial to. So, I have some stored British confectionery that I may crack out at midnight tomorrow.
Shen: That's a very good choice. I think I might be waiting with a spoon and a pint of ice cream, frankly, but we'll see. I'm not really sure yet.
Getting down to business, Sarah had suggested a really interesting topic for the show today, basically around executive leadership and the impact that new CEOs have had in two major companies in the consumer retail world that have been struggling in one way or another over the past few years. Our first company is McDonald's, now led by Steve Easterbrook, who's been at the helm for about 20 months at this point. Sarah, what is Easterbrook's story? Let's start with that. How did he get to that position? We'll go from there.
Priestley: Steve Easterbrook started January of last year. He's pretty young. He's only 49. He's been working at McDonald's almost since he left college. He started in 1993. He attended Hamburger U, which is the internal training program. He headed McDonald's U.K. and then went on to head international, and left for a brief period of time to CEO for PizzaExpress and Wagamama, in the U.K., which I know that you're not familiar with. But if you envision, if you will, a mix between Chipotle and Olive Garden that's kind of what you've got. It's a step above fast casual, because it still has table service, but it's in that realm.
Shen: So, he's obviously spent many years with McDonald's -- pretty much his entire career except for that short hiatus of just two or three years. Prior to Easterbrook taking the role, I think a lot of people who follow McDonald's, in general, who see headlines ... Comparable restaurant growth at the company was trending downward into negative territory across a lot of its major markets since 2012. The brand was losing, I think, a lot of its luster among consumers and investors. Competition in the restaurant industry was definitely very intense. You had fast-casual entrance, in general, among the big incumbents.
So, Easterbrook takes the job. What do you think, at the time, were the biggest issues on the docket that he needed to address?
Priestley: Well, I think for anybody coming into this position, it's the scale of the company. The company is so huge that any change they make has to be pretty impressive to move the needle. To just give you a very brief idea of how big the company is -- they once considered including blueberries in one of the menu items. In one day, overnight, they looked at buying one third of the U.S.'s capacity for blueberries. It's a massive company. Anything they do really has to be quite huge.
Then, I think you touched on a couple of the issues. There was definitely a lack of consumer favorability toward the brand. And you even saw this in the restaurants, they started to get a little bit degraded. And then, I think, competition from fast-casual companies. We've mentioned already Chipotle. And also, generally, the environment is moving much more toward healthy eating options, which they didn't cater to very well.
Shen: Sure. With that context, there's definitely been a lot of initiatives that he has kicked off, or things he has put into place to start what you call the turnaround. The stock's definitely bounced back quite a bit, I'd say, from the approximately $90 per share that it was trading at in January 2015 when he started. We can get to that a little later, I really want to focus more on the qualitative side. What do you think were the things that worked and didn't work? In general, what did he kick off since taking the reins, essentially?
Priestley: He started these initiatives. At the end of this year, they're going to transition from these turnaround plans to a more long-term progression. It's interesting, when he announced the turnaround, Forbes called the video in which he released it spectacularly awful. It was called a yawnfest. And the stock actually fell 2%. So you can see, initially, there wasn't very much support behind what he was saying. My personal feeling on this is that Steve Easterbrook happens to be British. I feel like we are not particularly good at show business and showmanship, and I think that's probably why his presentation was lacking a little bit feeling behind it.
Shen: Sure, like that pizzazz.
Priestley: Absolutely, which you are all very good at. So, some of the things that he started, I would split it up into four different sections. There was a general shake-up. He looked at efficiencies, better care of employees, all driving toward a better customer experience. Just to touch on the shake-up, I think this is very, very important for a company like McDonald's that's been around for a very long time. It's been beloved, and it's kind of rested on its laurels. It's officially kind of plateaued.
So, he's moving the office location from Oak Brook, which is a western suburb of Chicago, they've been there since 1971, to Chicago's Fulton Market District downtown. I think this really symbolizes a lot more than it actually delivers. It symbolizes the fact that they've been in the suburbs, they've been surrounded by fences and been separated from a lot of their competitors, and they've lost that competitive edge, they've lost that drive. He wants to bring them back in to get them to where their consumers are, attract top talent to the downtown area, cost savings from moving, too. But generally, just giving off this impression that things are going to change. So, that's a big step for the company.
The other thing is, he's restructured the company into four different sections. You've got the international lead market, high growth markets, and then two subsequent sections. And for all of these sections, he's changed the management. And that's a big structural change for the company, and it really shows you where they're focusing their attention. And I think it's a very sensible thing to do, with trying to devolve the turnaround plan they have.
With regards to efficiencies, he's cutting $500 million in SG&A [selling, general, and administrative expenses] by the end of next year. Job cuts are rumored to be part of that. I think there will be some attrition just from moving the location of the company, and then, the franchise models. The franchise model that they currently have is around 81%. They're 81% franchised currently. They want to move that to about 93%. The result of that will be better insight into the locality, so what people like in the area, especially in the Asia region, but also the margins are lot better. They're 82% for a franchise store compared to 15.2% for company-owned. That's huge.
Things like simplifying the menu -- the menu had grown 43% in the last seven years. That's huge. It had become incredibly cumbersome for the staff when they're trying to take customer orders, and also for the customers who, essentially, you want a burger and fries when you go to McDonald's. And that became hard to get.
Shen: Absolutely. There are a lot of surveys that research analysts and banks will go out and do, where they talk to franchisees about their experience, what they like and don't like from companywide initiatives. A lot of them had mentioned the fact that -- funny enough, one of the initiatives that a lot of people have attributed successfully to Easterbrook is all-day breakfast, with the fact that menu complication was a big issue for customer service in general. And I think that definitely flowed down to the customer experience. They just mentioned that trying to keep the restaurants running smoothly and efficiently, with all these different menu items, and the fact that it just took longer, for example, people in line trying to figure out what to order, that slows down the works all the way down the line.
Priestley: Absolutely. And you touched on all-day breakfast. All-day breakfast has been a huge driver for them, as you can see in the quarterly results. And they actually rolled that out in four months, which I think demonstrates that they've gone from such a cumbersome, slow-moving organization to actually being very fast to enact this. They launched it in October of last year, which is going to make the comps for this coming quarter very difficult for them, I imagine.
But they're also doing other things. They moved from margarine to butter for the flavor. They're using MSC-certified fish; preservative-free in their chicken nuggets. They're moving away from antibiotics. They're doing a lot of things to improve the quality of the food that they're delivering. And some of these things that they're doing, obviously, they're using as promotional to prop the products. But some things they're not. They're actually using sustainable beef sources, and they're mixing that in currently at a low percentage into what they already use. And they're going to gradually increase that until they're using 100% sustainable beef. This isn't something that they've talked about very much, and it shows you, I think, that their quality is being taken very seriously at the company, not necessarily just in advertising.
Shen: Yeah, it's not just marketing to compete with Chipotle, for example, to say, "Hey, we're also sustainable, we're also giving you the healthier foods that a lot of consumers seem to be wanting these days."
Priestley: Exactly, yeah. I think they were heavily criticized before Easterbrook took over for treating millennials like a homogeneous group, and trying to push forward healthy eating -- kale was always the joke. I think this is similar. They could be criticized for going toward sustainability as a ploy, but I really do think they're trying to embody that. And I think, generally, that it's just becoming a better organization. They're taking better care of employees. They've raised wages. There's tuition assistance, which is fantastic. I think 5,000 people qualify for Archways to Opportunity, which is helping them. And this has had a direct impact. It's reduced turnover, and it's also giving customers friendlier, happier people to interact with when they go to McDonald's.
Shen: Sure. And obviously that's very important. We've covered a ton of initiatives that you've mentioned under Easterbrook. I definitely think he's pushing the company in the right direction, especially with this bigger picture, long-term focus. Even going back to the beginning, which you mentioned, about the office move, that can really impact morale. That can really impact the culture, especially at headquarters, their corporate headquarters. And other companies have done that, too. I believe it was Gap, also, new leadership took over and just changed the layout, the interior design in the office. That can really flow through to the rest of the business.
Without getting too focused on short-term trading moves, I mentioned that the stock was up quite a bit over Easterbrook's tenure. Forty percent at one point this year, I think it was in May. The gains now are closer to 25%. But still, in a period of 20 months, really solid, especially for a bigger, well-known, mature brand like McDonald's. But if we look a little deeper at the financials, when Easterbrook took over, in terms of trailing earnings, it was trading at about 19 [times] by my calculation. Now, it's about 24 [times]. But earnings per share hasn't changed all that much. But looking at the financials, what do you think? Do you think the business is trending in the right direction, in terms of some of the big metrics we might look at, like comps and things along those lines?
Priestley: Absolutely. They had their fourth consecutive quarter of comparable-store sales growth, which is fantastic. I think last quarter, the comps got more difficult, so they are starting to slow, which affected the stock price. But if you look at the first half of 2016, their net income was $2.27 billion, versus $2.13 billion for the year previously. Earnings per share of $2.51 versus $2.09. So, they are definitely making empirical improvement.
Franchise margins were also up 6%. You are starting to see some of the cost of the improvement measures, such as the increased wages, taking effect. But if you look at some of the qualitative measures like customer satisfaction, their scores improved in seven out of nine markets. YouGov also does a consumer perceptions report. They take 1,400 companies, they rank what was most improved in terms of customer perception, and McDonald's was fourth. That shows you that they're making leaps and bounds from where they were.
As I mentioned, last quarter the pace of growth slowed due to harder comparisons, but also the industry experienced a 350-basis-point decline due to deflation at grocery stores. So, it became tangibly cheaper for people to eat at home than it is to eat out, whereas before, if you go to the lower fast food restaurants, that's always been touch and go for families. But now it's categorically cheaper to eat at home, which has impacted the whole industry.
Shen: Sure. I want to wrap it up here before we move on to our next company, which is another big name that a lot of people will recognize. Do you have any view for Easterbrook in terms of, he's kind of stabilized the business, and put it on the right track. What do you think is maybe, next year or five years, his view? Do you think it's going to be growing stores? You mentioned the refranchising and how important that is, especially with the improved margins they see. Maybe certain markets become a focus? Maybe in Asia-Pacific, for example?
Priestley: Yes, he absolutely has a plan to open more stores. I think they want to open 4,000 new stores. I will say, that needs to be 4,000 of the right stores. They're closing underperforming restaurants right now. The focus, absolutely, is in the Asia region. They're refranchising a lot of those because they've underperformed historically. The viewpoint on that has been that they didn't have the insider knowledge, if you like, into the locality. And that's what they're hoping to give them now. They've also opened their first restaurant in Kazakhstan. In different places like that, they're starting to have a presence. So definitely, growth is on the agenda. I would also say, he probably wants to apply some of these learnings and findings from what they've done in the U.S. to other countries, too.
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Our next company is the king of retail, Wal-Mart. Current CEO Doug McMillon has been in the position since February 2014 -- and even more so than Easterbrook, who has impressively had such a long tenure with McDonald's -- he's a company man through and through. He has been with Wal-Mart since his job as a summer associate there in 1984, when he was just 17 years old. The true case of somebody who started at the company and just rose through the ranks, now leading it. What do you think?
Priestley: I think he has rightly been praised from multiple sources, even COO of Facebook, Sheryl Sandberg, has given her praise to him after meeting him in an exchange program. Fortune has done an article called "The Man Who's Reinventing Wal-Mart." He's been called the most qualified person since Sam Walton. There's a huge amount of expectation on him. As you said, he's a company man through and through. He's from Arkansas. He worked there in high school, he's stocked shelves, he's done a $2.4 billion merger in South Africa. So he has a huge amount of experience.
And then, the other thing is, he's incredibly likable. In New York and Washington, D.C., where Wal-Mart has tended to have a worse reputation with how they treat employees, there's ad campaigns going on at the moment. You may have already seen them. They feature him on his Instagram feed, basically visiting the store and talking about how much better they're treating their employees. It's a very compelling ad, he's very likable. I read somewhere that he strikes the perfect balance between being very affable and aggressive, and that's exactly how I would put it.
Shen: Let's paint a little bit of a picture here. I think some people are familiar with the fact, once you reach the scale, similar to McDonald's, that Wal-Mart has reached, doing anything that really moves the needle for the company becomes really challenging. But, before McMillon took the helm and became, potentially, the most qualified CEO since Sam Walton, what was Wal-Mart facing? And then, we can get into the steps that he took.
Priestley: I would say Wal-Mart essentially came to prominence by saturating markets. They were the most convenient option at the lowest price. But the problem is, now, they have competition from all sides. From the lower end, Dollar General and the dollar stores' increasing popularity. Costco and Target as the big-box retailers. Kroger, they've really upped their game in terms of organic and fresh. I think Wal-Mart missed the mark on that, initially. If you look, a decade ago, Wal-Mart was 15% to 18% cheaper on groceries than Kroger. The gap is now 4% to 7%. So that's getting a lot shorter. And, the other thing is, in terms of convenience, Walgreens and CVS are leveraging their geographic dominance and offering groceries there, so people have another alternative.
More than all of that, though, is online. If you look, Amazon 2012 to 2015 doubled their sales. Wal-Mart grew their sales by 8.6% in the same period. It's the Amazon effect. There's definitely online sales, which is taking away from Wal-Mart revenue.
Shen: Yeah, with that kind of growth...unfortunately, consumer spending has not been growing at that rate. That is Amazon taking shares, especially, from a lot of the traditional retailers, Wal-Mart being, in my opinion, the epitome of that. But they're moving, it seems, forward, under McMillon's guidance. Obviously, big challenges, but still a very large, stable company. A very strong, incredible financial position. But, what is he doing to shore things up for another, essentially, generation of dominance in this space?
Priestley: I think you'll see a lot of similarities between this and Easterbrook, purely by the fact that I think they're both huge companies, huge examples of American commerce, and by consequence, they have similarities in their turnaround plans. So he's also doing a shake-up. He's moving execs. Currently, the head of China will now go and take over Asda in the U.K., which is struggling quite significantly. Greg Foran, who's a New Zealander, has been moved to the head of the U.S. And interestingly, when he first took the position, he listed no bad feedback from store managers. He then took this feedback and gave improvement plans, which he's going to review on the 30th of September. And he's put clocks that count down to the 30th of September in a lot of the stores and back offices in Wal-Mart. So, that's very interesting, that technique that he's adopted.
Again, Wal-Mart is focusing on making happier workers. CFO Brett Biggs said in the last earnings call that happier workers have been responsible for sales increases. That's interesting. Again, they've raised minimum wage, increased training. And then, I think they're focused most predominantly on e-commerce. If you look, the ShippingPass, that's to counter Amazon Prime. ShippingPass is essentially their equivalent for $50. McMillon has talked about going Wal-Mart-sized in e-commerce. I like the term. And he's doing that. He's bought JD.com in an acquisition in China, and Jet.com recently in the U.S., to really bolster their online offering.
[Editor's note: Wal-Mart acquired a 5% stake in JD.com, not the entire company as implied in the comments above. We apologize for any confusion.]
Shen: Yeah, we talked a few episodes ago about that. I was able to focus a little bit more on the Wal-Mart and Jet.com deal, if you're curious about that, because it is a very interesting tie up between them. How much of an impact it will necessarily have size-wise, Jet.com, though it's grown incredibly in its first year, is still very small relative to Wal-Mart, obviously. But it's the technology, I think, that Jet.com provides, and some of the logistical intricacy there, in terms of how they build a cart for a shopper, that Wal-Mart is really interested in. It'll definitely be, in the next year or two, an opportunity for McMillon to really leverage that and see where it goes.
Priestley: Yeah. He's made it known that that's his focus, and I think he's investing very heavily in that area. Interestingly, we were talking about McDonald's moving their headquarters to the downtown Chicago area. Their e-commerce headquarters is near San Francisco. They're doing that to "invade Silicon Valley for talent." They're very much aware that if they want to get the best people, they need to be in an attractive location. And they're doing that. And I think that shows the importance they're placing on it.
But all of these moves are, essentially, again, to improve customer experience. They want to meet the customer where they are -- very much representative of the push-pull model. They're going to offer pick-ups. They're pulling trucks into people's workplace parking lots, and they can do pick-ups from there. They've rolled that out to 30 more markets. They've added more products, improved their fresh produce.
And then, on the reverse side, they're also looking into cost efficiencies. They've divested their Suburbia brand in Mexico, which was their clothing brand. And then, looking even in the minutiae of detail -- the bakers, they found, were using spoons to frost, and they were wasting 36 truck loads of icing a year. So, they now have new scrapers not to waste those 36 truck loads. We laugh, and it is funny, but that's the kind of level of detail that these CEOs need to go into, if they're really going to get acute cost savings.
Shen: Yeah. For a company this size, that little bit on the spoon amounts to 36 truckloads a year. That's pretty incredible. So, we have a few more minutes. I figure we can look at their recent results as a single time period indicator of some of the progress they might be making. They reported on, I think, August 18, so very recently. The big thing that stood out to me personally was, previously, this was again tied to Jet.com, their e-commerce growth was pretty strong. It was over 20% not that long ago. It was trending downwards, then, bumped up again to 12% for this quarter. What else stood out to you?
Priestley: They had organic sales growth of 2.8%, which is great. Comp-store sales at 1.6%. This amounts to their eighth consecutive quarter of positive same-store sales growth. They're definitely getting into that safety zone, I would say, where they're securing their seventh consecutive quarter of positive traffic. Interestingly, they also noted that sales have increased from their own staff members, which may be showing a greater positive feeling toward the company.
International business was the underlying negative. 2.2% underlying sales growth, which is great. But if you break that down, the U.K. seriously continues to struggle. Comp sales decreased 7.5%, and operating expenses were up 8.3% across the board due to wage hikes and things like that. So, the general trend is definitely positive. There are some areas they still need to improve, and there was a lot of focus given to those on the earnings call. So, I would say that's in good shape going forward.
Shen: OK. Now, at this point, as we're wrapping up, we have the story for McDonald's, we have it for Wal-Mart. Two very different businesses with their own challenges. But Easterbook and McMillon's turnaround initiatives seem to share quite a few themes. What are your final thoughts, takeaways, in terms of some of the similarities there, but also in terms of the importance of leadership? I think both of these examples that we looked at definitely took on a hands-on approach. I think, you mentioned earlier, with McMillon, for example, his ability to think "big picture," to drive and innovate, but at the same time, to have a really good grasp, the fact that he rose up the ranks, of the day-to-day operations being so important.
Priestley: Absolutely. I think this is an incredible example that we have right in front of us of two CEOs and a turnaround plan. You don't get that very often. They're both young, they're both company men, essentially. They both face similar challenges. Scale is huge for both companies. They have exposure to different regions. I think it's about 60% for McDonald's, international exposure, and about 30% for Wal-Mart. So they both have those effect challenges. They're both trying to return value for shareholders. These are value stocks, and there's that underlying pressure on them to do that.
And I think they've both taken a very, as you said, hands-on approach to shaking up the way the company operates at a fundamental level. Not only is that difficult to do, it's also incredibly brave, especially if they have been brought up, essentially, in their careers under this management, and they've been learning that way to manage, their whole careers. It's difficult. And, as far as, how much does a CEO actually impact on the ground -- there's 3,000 books a year written on the topic of leadership. It's a very highly debated area. I would say these are two examples where they're having a direct impact. I would tend toward the Upper Echelon Theory of Lichtenstein and Collins, who did a good-to-great analysis, and say that executive values do have a direct impact on the way that companies operate. This is a tangible example of that.
Shen: Perfect. Sarah, it was awesome having you on. I really look forward to having you on the show again. It's nice to have someone in studio with me to talk to, instead of talking to my computer. If you enjoyed the discussion and you want to learn more about leadership and some of the great CEOs in the sector and others, there's also an excellent episode of the Rule Breaker Investing podcast from Motley Fool co-founder David Gardner. He talks about his experience and lessons that he learned from another highly respected CEO in the consumer world. That's Howard Schultz, the founder of Starbucks. That episode went out on Aug. 10th, and it can be found at fool.com/podcasts, along with some of our other great shows.
You can also continue the conversation with us via Twitter @MFIndustryFocus, or send us any questions or comments via email to firstname.lastname@example.org. People on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against stocks mentioned, so don't buy or sell anything based solely on what you hear during the program. Thanks for listening and Fool on!
Sarah Priestley has no position in any stocks mentioned. Vincent Shen has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Amazon.com, Chipotle Mexican Grill, Costco Wholesale, Facebook, and Starbucks. The Motley Fool recommends CVS Health. 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.