2019 has seen more than a couple of CEO departures. In this week's Industry Focus: Consumer Goods, host Dylan Lewis and Motley Fool analyst Dan Kline take a close look at the stories behind McDonald's (MCD 0.24%) and Gap's (GPS 0.75%) recent C-suite change-ups, and what they mean for the companies. Listen in to find out what precipitated the departures, what shape these CEOs are leaving their businesses in, what this means for Old Navy's spin-off, what specific issues each set of management teams will have to tackle to succeed in the future -- like updates to technology, ease of use, accessibility, maybe even a complete product overhaul for the long-struggling Gap -- and more.
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This video was recorded on Nov. 12, 2019.
Dylan Lewis: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. It's Tuesday, November 12th, and we're talking about some CEO departures in the consumer goods space. I'm your host, Dylan Lewis, and I've got fool.com's Dan Kline with me on Skype. Dan, what's going on, man?
Dan Kline: I don't know! Has the bitter cold set in there yet?
Lewis: Oh, it most certainly has! We've got the threatening of some snow, I think, this week, and possibly later in the month. I can firmly say that we're in deep fall at this point, Dan.
Kline: People are freaking out here. It might hit the 70s.
Lewis: [laughs] It's oddly reassuring, I have to say. It should be cold this time of year in the Northeast. I'm glad that it's finally getting cold. Nice to put on the sweater, enjoy that sweater weather.
Kline: I don't know that it should be like birds-fall-out-of-the-sky cold.
Lewis: [laughs] Yeah, no, we don't want that. We definitely don't want that. But I'm OK with dealing with a little chilly weather here and there. Makes me feel like it's truly football season.
Kline: Absolutely!
Lewis: All right, Dan, we had a couple of pretty big news items come up in the consumer goods space over the past week, I think in the period between the most recent CG show and this one. So, we're going to be tackling a couple of those today. The big headline one, this was the business story of last week, was, McDonald's CEO Steve Easterbrook is stepping down and they have a new CEO coming in.
Kline: This is shocking because he's a really good CEO. He was pushed out for reasons that are perfectly valid, but the scary thing here is, this is a guy that took a company that was struggling and really reversed course. He pushed franchisees to make changes. He took a company that had operated the same way for like 35 years and really dragged it kicking and screaming into what I'll call the Starbucks era, where everything is digital, customers are first, it's a very different model, and he was very successful at it.
Lewis: For the specifics here, you mentioned he was pushed out, Easterbrook was having a consensual relationship with an employee. While it was consensual, it was in violation of company policy, so they decided it was time to move forward with new leadership. But, yeah, he operationally has been an excellent CEO. You look at pretty much all of the important metrics when it comes to McDonald's over the last four years or so, and they've been incredible.
Kline: Yeah. The stock has more than doubled in price. It was in the $90s when he took over. It was just under $200 when he left. That, plus comp sales in the U.S. have turned around, even satisfaction with customers, given that some of the things like digital ordering -- you wouldn't think, and I've talked about this on the show for maybe three years, how silly I think McDonald's delivery is, but it clearly works. It's about 1% of sales now, going to be about 4% of sales three years from now. Most importantly, order size is double what people order when they're in a restaurant. I think some of that is anonymity. If you're sitting at home, and you're ordering McDonald's, and there's no one you have to look at, even to hand it to you, it is pretty good that you can get three shakes because the guy delivering doesn't know if there's 10 people in the house or you're eating 100 McNuggets all by yourself.
Lewis: It's a shame-free shake, Dan. [laughs]
Kline: [laughs] It is!
Lewis: Yeah, and I think what we see with McDonald's here is somewhat similar to what we've seen with Domino's in terms of where they've been successful. The challenge that a lot of these companies have had with going omnichannel is, you're not really sure what's going to work, what's going to resonate with customers. You need to just throw some stuff at the wall. I think a lot of people would probably be skeptical of a delivery option. Now, they might not ever get to the point where 40% of their sales are coming via delivery. But, if they have power users who love the delivery option and are regularly using it, then it's something that's going to stick around for them, and you need to offer different things to customers to see what they want.
Kline: Yeah. In the U.S., they're using Uber Eats, so there's some integration issues, but there's no massive expense to them. They didn't build out their own delivery network. McDonald's is one of the companies that has enough money to take everything that might work and throw it at the wall. They're using some AI-driven technology in the drive thru line, that, based on the weather, the time of day, and ordering patterns, as you order, it shows you what you might want. If people who order a Big Mac often get a Filet-O-Fish with it, even though that's not maybe what would pop into your head, you're going to start to get that predictive technology helping you do stuff. They've added things like kiosks in the store. I think kiosks will have that same effect, where you'll be more willing to go large fry or add a shake or add an apple pie, because you don't have to order with a human. They're supplementing drive thru with a pickup model, where you order on the app, and you go to designated spaces. Three years from now, they may not do all of these things; but whichever ones work, they're going to be in a position to double down on and roll out. Steve Easterbrook put that in place, along with an executive team that, everybody steps up one. It's kind of a New England Patriots next man up philosophy. I think they have the team in place to continue executing. This is no longer a turnaround, it's an execution story.
Lewis: I like your point about the kiosks there, Dan. I think so often, we think of online ordering or these kiosks that don't require you to interact with a customer service rep, you can just order and see the whole menu in front of you -- we tend to think of them as convenient options for customers. The reality, I think, is that they often wind up adding quite a bit to the ticket for these customers, because you're so much more aware of these combos that exists, these deals that exist. Oh, you can get a little tack-on drink for an extra dollar. McDonald's is happy to offer you those extra things because it's boosting their same-store sales growth.
Kline: Yeah. I think Wawa has mastered this. You go into Wawa, and you're using the little ordering kiosk, and you're intending to just get a coffee or whatever, and it's like, "Would you like a piece of pie with that? How about a meatball sub?" [laughs] It really does take away the shame, it makes it very easy. And sometimes, it reminds you that you actually do want something. Maybe you forgot to order a bottle of water, and it says, "Hey, you didn't get a drink. You want a drink?" "I do want a drink. I want a bottle of water." This is technology that's easy for consumers. It's good for the company.
There's going to be a little bit of a bump in the road. There's been some early adoption, people walk in and they're not really sure how it works. But I think that's just like mobile checkout anywhere else. As long as you devote personnel to it and take people through it, it's very simple technology. It's technology my mother, my grandmother could use. You just have to get them familiar with how it works and what the process is.
Lewis: Now, Dan, when I look at Easterbrook's tenure at McDonald's, you have this legacy brand that I think was struggling to find its way in the new era of retail. He was someone who basically grabbed everybody and took them along for the ride, and made them a digital-first business in a lot of ways. They really transformed as a company during his time there. Are you concerned at all that you have this really transformational leader stepping away from the business?
Kline: I'm a little bit concerned only because he was such a dynamic leader. But the reality is, the heavy lifting for the next few years is over. He had to sell franchisees on spending the money for the restaurant of the future -- the kiosk, the drive thru changes. He had to convince them to put in the McCafé upgrades. McDonald's is about equal in revenue produced by franchisees and produced by company-owned stores. So, he had to go get people to spend half a million, a million and up, to change their stores. And when you were making money, that's something a franchisee doesn't necessarily want to do.
Now, the reality is, something like mobile ordering and delivery is probably becoming table stakes for any restaurant business, unless you're truly experiential. I think the reality is, he did what had to be done, and now, it becomes the next generation of leaders making sure it keeps working, and that they stay ahead of things. They need to keep testing things, they probably need to do a little bit better on product innovation. It's been a long time since you were really excited about whatever the quarterly new thing from McDonald's was going to be. I think Burger King has really beaten them in that area, in trying some truly wacky stuff. I'd like to see, I don't know, bacon-stuffed Tater Tots, or who knows what. They were trying those Shake it! fries and different things. I'd like to see more of that. I'm fairly convinced the new team can do that.
Lewis: Yeah. We saw what a huge boost all day-breakfast became for McDonald's. I think what's tough when you look out at the space now is, there is basically this arms race going on between all of the fast food companies. I think Taco Bell has done an incredible job here of providing novelty menu items to get people in the door, and while they're there, they're going to be buying other stuff, and they're going to be reintroduced to the idea of what's on these menus, which leads to those repeat visits. I think, to your point, Burger King did a great job partnering up with Impossible to bring the plant-based protein burgers to the mainstream. McDonald's lagged them a little bit there. I think they need to do a little bit of menu innovation. But, it seems like the blueprint is there operationally for the stores.
Kline: Yeah, absolutely. With menu innovation, I don't want to see the Pringles Big Mac. I don't want to see the Funyuns Quarter Pounder, or whatever gimmicky thing that Taco Bell might do. What I want to see is more of the equivalent of the pumpkin spice latte, where they're trying different things that will be on the menu maybe once a year for a quarter, maybe like the McRib, something that bounces around and isn't always available and attracts some attention. I think McDonald's could score with, maybe during football season, they should do buffalo wings. I know they failed with wings a bunch of times, but I'd rather they took those big swings than went that gimmicky route. If you find one thing that excites people every year, you can pretty quickly build a calendar. And yeah, all this is about making sure the ship stays on course. The company is doing great. Comp sales are up, traffic count is up, delivery is growing. You just have to make sure that they don't revert to those staid, complacent ways.
Lewis: You know, Dan, I heard you say wings. I think that dovetails very nicely with the delivery business they're trying to grow. I generally think of wings as something I'm ordering in a sports bar because I'm watching the game, or I'm ordering delivery because I'm at home watching the game. I don't really think of myself as eating wings quickly on the go in a fast food setting.
Kline: Yeah. It may fit well with delivery. One of the things McDonald's does during football season -- I joked about the 100-piece McNugget, but in many markets, they offer a 100-piece McNugget. That's not for you or me to sit down and eat alone. That's the theory that I'm some cheapskate who had his friends over to watch football, and I'm putting out a platter of 100 McNuggets instead of getting some pizzas or Chinese food. McDonald's could use more things that deal well with delivery. I've complained, I don't think a cheeseburger is a good delivery product. I think fries are the single absolute worst delivery product, followed quickly by McNuggets. Chicken wings might alleviate that, and get the person in the group who opposes ordering McDonald's because it's not going to travel well say, "Oh, OK, I could get that. That'll heat up pretty well in my oven at home or my microwave."
Lewis: Listeners, as an aside, if you ever want to make a great entrance to a party, show up with 100 McNuggets. It is one of the best ways that you can roll up to a party. I hosted a Friendsgiving two years ago, and my friend was studying for the GREs at the time, so he didn't have a chance to cook anything, and he showed up late, and he had a tray of Chick-fil-A nuggets or strips, whatever they call them, and was immediately the hit of the party. Everyone wanted that instead of the turkey that I'd slaved over for like five hours. Lesson learned, you can just show up with something that you got from a fast food joint and make a pretty good impression, Dan.
Kline: It also works at business meetings.
Lewis: [laughs] It also works at business meetings. Dan, Easterbrook had a wildly successful term at McDonald's. Not so much the case for the other executive that's departing and that we're talking about today.
Kline: No. Poor Gap CEO Art Peck. Now, they're calling this a step down. I think it's more fleeing from a burning ship. Or, I guess, ships can sink. I guess they can burn, too. What happened is, Gap has been prepared to spin off Old Navy. The reality is, Peck was going to be the CEO of a company that was only worth, politely, let's call it 10% of the total value. He was looking at a much smaller job anyway. And now, as he leaves, the company has shared some pre-earnings, and the numbers don't look good. They're still making money, about $0.34 to $0.36 a share, but comp sales are negative not only at Gap, where they're going to be down 7%, down 3% at Banana Republic -- and this is the bad one -- down 4% at Old Navy. So, the growing brand, the one they were going to spin off that was going to be the darling, is now moving in a negative direction. That's not good.
Lewis: Yeah. Listeners may remember that we did a show on the Gap/ Old Navy spin-out a little while back. For a while, the narrative with this business has been, Old Navy has basically been keeping the ship afloat, to go back to your ship metaphor, Dan. I think they were really hoping that this business could continue to post strong results, they could spin it out, and it could be realized for the strong operational business that it is, in this new age of retail. The declines are concerning because that totally flips the narrative that they've been selling to investors.
Kline: Yeah. Here's the thing. I don't want to panic about one quarter. But, they planned to open another 1,000 Old Navy stores, and maybe the market won't bear that. The whole spin-off is cast into doubt. You have two problems. The Gap has an interim CEO, one of the founding family members of the company. It's going to be very hard to get someone to take a job that's sort of a big job today, but Old Navy has a CEO, so the reality is, you could do two things -- you could not do the spin-off and make her the CEO of the entire company, and either sell off The Gap or figure out how to right-size it; or, you could find someone who just wants to run The Gap, and I don't know, that doesn't seem like a very attractive job to me.
Lewis: No. I think that they've had this problem, where so many people have been brought in to try to turn this brand around and bring it back to the mindshare that it enjoyed in the 90s, when the entire cast of Friends was wearing Gap. That's not popularity or hipness that they've enjoyed in, I guess, about 20 years at this point, and they haven't found someone who can get them back there.
Kline: Gap has always been a cyclical company. I will point out that there was a large period in the 80s where that was the defining uniform, and then it went into a fallow period. But, when it was in that fallow period, there was still a 30-something, 40-something that bought denim shirts, that bought wardrobe staples, and there was no pride in it being from The Gap, but, they sold jeans at a decent price that were quality jeans. It sort of lost that piece of the business and became very dependent on being hip or not hip. Not only is it not hip, it's also largely mall-oriented. It's hit or miss which malls are doing well and which malls aren't. Upscale malls tend to be doing very well. But if there's a Gap in every mall and a third of malls are struggling -- I made that number up, but something like that -- you're going to have struggles with The Gap simply because of where they are. Whereas Old Navy is a destination. It's inexpensive, you go to Old Navy not necessarily for a reason, you might just find stuff. That's probably going to be a better story. But this entire company's in a weird position with the internet and the overall idea of, will people leave their house to buy clothes?
Lewis: Yeah, I don't really think of Gap, Banana Republic, or Old Navy as particularly digital-first brands. I don't think that many consumers do. So, when we talked about Old Navy in the past, we were saying, because of the price point, because of the logistics that go into returning things, they aren't quite the built-out, online brand that some of these other new-age retailers are, and that's fine, because they're able to make it work. The numbers aren't really showing that, based on what we're expecting for this upcoming quarter. So, the CEO, Sonia Syngal, who was supposed to be the Old Navy CEO and run that company, is going to be facing some unique challenges if they wind up running with this spin-out. But, I think, yeah, from a corporate perspective, they also now have to try to get someone to take this very well-known legacy brand and do something with it. The person that will be running the ship on the other side will be owning Gap, Banana Republic, and Athleta, and none of those brands are really lighting the world on fire.
Kline: Yeah, and they're mall-based. Look, I think all of these brands should be looking at what TJX Companies is doing with their websites. You go to Marshalls or TJ Maxx, again, the thrill of the hunt. They're trying to translate that into a digital experience. I think that's definitely something Old Navy could model after. With The Gap, I think you just really need to change your business. Who are you going after? There needs to be a clear core customer. Is it me? Is it a guy in his 40s who doesn't want to think that much about clothes? It's probably not hipper, fashionable people. That brand has been lapped. Is it a retro audience, that it makes a comeback, the way Izod always does every decade or so? I don't understand who the focus is. I think I'd want a CEO who came in and said, "This is my vision. These are the products we're going to launch. This is where I want to go. This is the customer I want to target." That's very expensive, and not really an easy thing to do.
Lewis: Yeah. When I think Gap, I think perfectly inoffensive clothes. No one's going to call you out for wearing something from Gap, but they're probably not going to tell you that you look fantastic, either.
Kline: You just described what I'm going for. [laughs] Except the problem is, Gap, in my opinion, is an expensive price point. I don't wear pants very often. I live in southern Florida. If I'm going to go buy a pair of jeans that I'm going to wear four times a year when I come to visit you guys in the office during the winter months, I'm more likely to go to Old Navy or to buy something on sale. A pair of Old Navy jeans, yes, they're not going to be durable, but how durable does something have to be that I only wear a few times a year? And, they may be a third of the price. With Target getting more heavily into Levi's, maybe I'll buy Levi's at Target. Gap is in a no man's land. It's sort of expensive for not being anybody signature look.
Lewis: I want to put some numbers to Peck's tenure, because I think they'll illustrate exactly why this brand has struggled. He took over around 2015. Back then, operating income was over $2 billion. It has steadily declined since. Over the last 12 months, it's around $1.4 billion. You look over at the balance sheet. Inventory is rising. The company's cash has been slowly worked down. We're seeing a lot of the hallmarks of a brand that's starting to struggle.
Kline: Yeah. What you need to do as the new CEO -- I'll make my pitch to be the new CEO of Gap.
Lewis: [laughs] Love it!
Kline: You need to get rid of that inventory. If you're in a situation where you're going to spend a year revamping your brand, spend the next three months, the Christmas season, just turning dead inventory into cash. I don't care if that's 50% off, 60% off, if you blow it out through the outlet stores. Whatever you do, make the decision that this stuff didn't work. It's not a perennial. It's not a slow seller that we can eventually get rid of. Turn it into cash. Then make your decisions. Are we going to double down on Athleta? Are we going to go into new areas? Is it technology? Is it digital tailors? You have cash flow, you have money to spend. But a billion forward doesn't go that far. So, if you could turn your dead inventory into another $300 million, $400 million that you can spend on reinvention... And, you need a plan. And that isn't one thing. You're not going to bet everything on swimwear, or tuxedos, or whatever it is. But you have to try five or six different things, and really stake out what works, and go with it hard. We've seen companies that were struggling. Target was really struggling in terms of clothes. They made a major pivot into going into owned and operated brands, and it worked. You could point to Best Buy. Same thing. They went to store-within-a-store models. Whatever it is. Maybe Gap consolidates more of its brands under one roof, so the Banana Republic customer, the Athleta customer, is being more exposed to Gap products. I don't know what the answer is. That's why they're not going to hire me. But I think you have to find someone who can take a company that's still profitable and figure out how to stop the bleeding and get to the next point.
Lewis: Yeah. There are a lot of tailwinds in the industry that they should be able to benefit from. Denim has been pretty big. We talked about the success of Madewell when we were discussing the Old Navy spin-out a couple of weeks back. The athleisure market has been huge, too. So they have players in those spaces. They just haven't been able to modernize in a way that has resonated with consumers. I think it's actually fitting that we're talking about Easterbrook and Peck here together, because I think all the things that you could commend Easterbrook for in his tenure as the CEO of McDonald's, you could criticize Gap for not doing well.
Kline: Yeah, absolutely. If you walk around a mall -- I have a 15-year-old, so I walk around the mall fairly often -- a lot of stores that sell denim are doubling down on inclusive sizing. They will have a much wider range, they'll fit different body types. Dylan, you have a girlfriend. I'm married. Women fitting jeans, no matter what their body type, can be somewhat more challenging than it is for men. The Gap hasn't really embraced that. They still have sort of the same styles they did when I was in high school. Could I see them going to a semi-custom model, where you come into Gap and they take some measurements, and maybe they're not fully customizing but they're putting you in the right line, and they're adding three or four different types of lines for different shapes, different body types? I think there's a lot of things that are becoming very normal within the fashion industry that Gap is not doing. For men, looking at what Untuckit does, offering an untucked shirt that fits well on different body types, going with broader ranges of sizes. There's a lot of things Gap could do, and they're mostly doing exactly what they were doing when I was a big customer in 1992.
Lewis: And that's a problem, Dan.
Kline: [laughs] It isn't for me, but it is for those people.
Lewis: [laughs] Yeah. I think that they really have their work cut out for them. They have reiterated the plans to spin out Old Navy, even in the wake of this announcement. Now, we'll see whether that happens. I think that it will really determine the direction of their CEO search, if they wind up spinning this out. It'll be a very different proposition if Old Navy is part of the portfolio or not.
Kline: Yeah. Let me clarify one thing I said there. I pointed out that they still have cash flow. The reality is, if they spin off Old Navy, most of, if not all of that cash flow goes with Old Navy. But, what Gap will get is a one-time infusion of cash from that spin-off. They're going to have to make some decisions very quickly and spend their money very wisely.
Lewis: Yeah. I think it necessitates a clear vision that people are 100% bought into. The flexibility of having that cash coming in from Old Navy while you guys are all under the same umbrella gives you the time to think a little bit more about your turnaround, because cash is constantly coming in from the successful brand. If they decide to spin it out, that's not going to be happening anymore. They're going to get that lump sum, like you said, from the IPO, and that's it. That's what you're working with.
Kline: Yeah. Look, I think you need to look at what's working in the marketplace. If you could do a version of Madewell that costs 30% less -- same thing with Untuckit, the shirts are very expensive. If you could do a take on that that's still high quality but costs half as much... Athleisure. Going into Lululemon, a pair of yoga pants there is astoundingly expensive, and a lot of people have lived in that, "Hey, we're just as good," they might not be quite as good, but they're a lot less pricey. I think there's absolutely room to play here, and a way for Gap to pick and choose from other successful models, and try different things; but they're not going to be able to make all that many mistakes.
Lewis: Yeah. And I think the future is going to be really tied to whoever they bring in as the successor to Peck.
Kline: So, Steve Easterbrook as the successor?
Lewis: [laughs] I think he needs to spend a little time outside the limelight. I think that's generally how that works.
Kline: [laughs] And I'm pretty sure that his experience is execution, and Gap is not an execution game. They could absolutely step up their in-store and their execution, but that goes hand-in-hand with having new products. If they bring in, say, a new line of jeans for shorter guys -- I am not the tallest guy in the world -- then they also have to execute in making sure their customer service people match me to that line of jeans, and that it's not called Short Guy Jeans or something that makes me feel bad. There is an execution story here, but it's in line with really getting the product right.
Lewis: Somewhere, one of our listeners just thought of starting a business called Short Guy Jeans, Dan. In two years, when you see that website, just know you were the inspiration.
Kline: I'll be a customer, not an investor.
Lewis: [laughs] Dan, thanks for hopping on today's show and talking with me!
Kline: Thanks for having me!
Lewis: Listeners, that does it for this episode of Industry Focus. If you have any questions or you want to reach out and say hey, shoot us an email over at [email protected]. Or, you can tweet us @MFIndustryFocus. If you want more of our stuff, subscribe on iTunes or wherever you get your podcasts. You can catch video extras from our YouTube channel as well.
As always, 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. Thanks to Austin Morgan for all his work behind the glass today! For Dan Kline, I'm Dylan Lewis. Thanks for listening and Fool on!
