McDonald's Corporation (NYSE:MCD) under CEO Steve Easterbrook has a pretty clear idea of what it wants to be when it grows up. The gradual phasing out of antibiotics, preservatives, and high-fructose corn syrup in its products, the packaging and digitization initiatives designed to contemporize the brand, and the renewed attention to metrics such as speed, quality, and order accuracy -- all such actions are intended to remake the company into an exciting destination on a par with fast-casual restaurants.
To the oft-stated dream of becoming a "modern, progressive burger company," Easterbrook has lately added a new goal: to "reassert McDonald's as the global leader of the IEO [informal eating out] industry."
Such a vision has its financial counterpart in comparable sales that trend consistently higher, quarter after quarter, based both on pricing power and improving guest counts. For investors, looking across turbulent waters of competition and changing consumer tastes, comps that rise predictably represent the green riverbank on the other side of the river that McDonald's is trying to reach.
The only problem with this lovely picture is that guest counts in the U.S. have been declining for years, pressuring the very comps they should support. Internally, at least, executives admit that this is not a problem that can be overlooked.
And so far, the materials at hand to construct a bridge to rising comps seem ill-suited for the task. The company has "all-day breakfast," which launched last year's turnaround, though its effect is fading. McDonald's also has use of its "McPick 2" value menu, which enjoys higher price points than the company's old dollar-based value offerings.
Neither of these should be thought of as a permanent lever for traffic. McPick 2 in particular, while fulfilling a segment of market demand, ultimately won't boost franchisee margins or draw in new customers, and it hinders the company's efforts to burnish its image.
In truth, McDonald's may be stuck on the wrong side of the river for a while. It may be years before the company can achieve enough ingredient evolution to convince customers they're getting an equivalent product to, let's say, a Shake Shack (NYSE:SHAK) burger, and to persuade them to happily fork over $6 to $7 for the equivalent McDonald's sandwich.
And there's danger in trying too hard to imitate the strategies of smaller competitors such as Shake Shack, specifically their supple use of limited-time offers (LTOs). It's probably tempting, but so far McDonald's has avoided pushing out successive waves of higher-priced, premium LTOs to compete with fast-casual chains, as customer perception hasn't yet caught up to company ambition.
Instead, the organization's current approach to menu innovation, while not optimal, entails less risk. McDonald's appears to be trying to raise guest counts by dressing up core items on a limited-time basis. It's a practice that Restaurant Brands International's (NYSE:QSR) Burger King excels at. Witness the bizarre merger of Burger King's core-menu Whopper sandwich with a burrito this past summer, the "Whopperito."
Perhaps not as daringly, this week McDonald's announced the testing of the "Sriracha Big Mac" LTO, which comes on the heels of two Big Mac LTOs set to run nationally next year, the Grand Mac and The Mac Jr. This bridging strategy toward higher guest counts is at least consistent with the company's focus on raising core item sales -- a prime component of its original turnaround plan.
For some time to come, McDonald's will have to work within a tight set of constraints, and not just the ones I've mentioned. As I've written on several occasions, McDonald's appears to have chosen to purposefully take on debt to return massive amounts of money to shareholders. It's finally on pace to complete its three-year, $30 billion shareholder return program by the end of 2016.
Adding debt and sending the check directly to shareholders via dividends and share repurchases prevents an activist shareholder from swooping in and using balance-sheet resources to restructure the company. But as a result, there's barely any credible leverage left, as McDonald's sits with a credit rating just above junk status. Earlier this month, it received another downgrade on its long-term debt from Fitch Ratings, to "BBB," which is considered investment grade, but by the slightest of margins.
In essence, McDonald's doesn't have huge amounts of capital left to partner up with franchisees on a multi-year store upgrade, or entertain acquisitions as it has in the past. Menu innovation remains the single item that could most help the company construct its bridge to higher traffic and rising comps. And it's a relatively cheap way to drive sales. At some point, the company will have to introduce new, successful core items that insert a truth beneath all the rebranding efforts. Until then, McDonald's may remain stuck on the wrong side of the river.