With McDonald's currently doing very well -- last week, it reported that total systemwide sales increased 11.1% in September (6.0% in constant currencies) and U.S. same-store comps were up a fabulous 10.0% -- it's easy to forget how bad the company's results were, and the contempt hurled its way by investors and the media.
Let me refresh your memory. When McDonald's chose to hire the insider Cantalupo, it was viewed as proof that the company's bureaucratic, inbred culture would continue. A Reuters article at the time summarized the conventional wisdom:
Jim Cantalupo is taking the reins of the world's largest restaurant company as its markets mature, competition balloons and consumers become more selective in what they eat...Investors have come to see McDonald's as a slow-moving monolith facing market saturation, increased competition, changing tastes in the U.S. fast-food market -- its largest with some 13,000 restaurants -- and a host of problems overseas where troubled economies hamper growth...The clock is ticking for Cantalupo, who steps into the hot seat in the wake of seven earnings declines in the past eight quarters.
There can be no fixing of McDonald's because there is no McDonald's. The company itself can't control its franchises. The franchises used to be the source of so much growth and so much profit, but now the franchises can't be reined in and they can't be fixed. McDonald's has become a rogue operation...What can McDonald's do to save itself? Nothing at this point, nothing.
Nor were investors mollified by Cantalupo's strategy to turn the company around: On the day of his first conference call with investors in January, the stock fell 5% as one analyst wrote, "This does not seem like a new era from McDonald's, but instead a continuation of the (disappointing) recent past." Shortly thereafter, Cramer wrote in another article, "McDonald's still doesn't get it...This 'change' is just the same old evolution; nothing revolutionary here. In fact, the company is still in massive denial about what is happening. It doesn't recognize that there is a crisis...The orchard is rotten."
Yet today, less than 10 months later, sales have surged, the stock is up sharply, and the company's worst critics are singing a different tune altogether. Last week, Cramer wrote: "I thought I would never write this but the turn is palpable. The company has really gotten its act together...Who knows, maybe you really can change these big companies with change at the top. That's certainly what happened here."
So what exactly did Cantalupo do to fix McDonald's? Two things: He adopted the right strategy and -- this is where he really earns kudos -- acted urgently to carry it out.
As I discussed in my last column, like many long-standing, high-growth companies, McDonald's began to saturate its core markets yet failed to recognize this and slow its growth. Consequently, new restaurants performed poorly and cannibalized established ones, margins and returns on capital fell, and the stock followed. McDonald's compounded this mistake by engaging in an insane price war with Burger King and failing to take care of the basics that made the company great: tasty food, clean restaurants, quick service, and consistency across the chain. In addition, it pursued new restaurant concepts that proved to be little more than expensive distractions.
Cantalupo deserves credit for recognizing the problems and taking appropriate actions: scaling back growth and slashing capital expenditures, winding down the price war, putting non-core concepts on the block, reemphasizing the basics, etc. But I'm not hailing Cantalupo as CEO of the Year for adopting the right strategy -- the basics were obvious to nearly everyone. The real challenge was actually carrying out the strategy.
How many times have you seen a CEO announce a new strategy that appears to be exactly right for turning around a declining business, but then nothing happens and the company continues to fade?
I see it happen all the time, generally for three reasons: The company's problems are so intractable that even the best-laid plans can't save it; the CEO is just telling the investment community what it wants to hear but isn't really committed to change; and/or the culture is so ingrained and the bureaucracy so entrenched that the company successfully resists the CEO's attempts to change it.
When I was evaluating McDonald's before purchasing the stock shortly after Cantalupo took over, there was little doubt in my mind that the company remained one of the world's great businesses. It had a powerful brand, high margins, huge cash flows, and a worldwide presence. Despite horrible mismanagement, McDonald's was consistently pounding out nearly $3 billion of operating cash flow. In short, it was a classic case of what Warren Buffett once spoke about: "Invest in a company any idiot can run because sooner or later any idiot is going to run it."
Nor did I doubt Cantalupo's sincerity. The key for me boiled down to the following question: Could Cantalupo overcome the challenges posed by McDonald's infamous bureaucracy and angry franchisees?
Interview with a franchisee
I stumbled upon the answer almost by accident, when a friend introduced me to a McDonald's franchisee. To summarize his comments, he couldn't heap enough scorn on the company's prior management and its bureaucracy but, conversely, couldn't praise Cantalupo enough. Here are some of the highlights of what he told me:
Franchisees had become more and more disgruntled, in part due to the perception that the company had stopped listening to them. Cantalupo was taking rapid action to address this issue, by holding frequent urgent meetings with franchisees nationwide, often bypassing the corporate bureaucracy.
The company had been cannibalizing itself. When I asked which of his competitors worried him most, he snorted and said, "The only competition I worry about is McDonald's. I have one store that competes with Burger King, Wendy's
(NYSE:WEN), and Popeye's on adjacent corners and I outsell all of them put together. But I get hurt if McDonald's opens another restaurant nearby -- it can cost me $500,000 in annual sales." He said that Cantalupo understood this problem and was slowing down new store growth.
McDonald's "Made for You" system (in which food was cooked to order rather than made in advance and put in bins) was a disaster because it slowed service. The key, the franchisee argued, was to reinstall bins but only use them during peak times when the product is moving so quickly that the customer will get a fresh, hot burger even if it's not made to order (this would, of course, cut service time dramatically). He believed that the company would soon allow him to proceed with this plan.
- In its reckless pursuit of growth, the company had abandoned its rigorous "full field" evaluation standards of franchisees, so cleanliness, quality, and consistency were slipping. He said Cantalupo was restoring "full field" evaluations across the system and removing bad franchisees.
Overall, he was extremely optimistic about the sensible, rapid, forceful changes Cantalupo was making and concluded our conversation by saying, "If I had $5 million right now, I'd invest every penny in McDonald's stock." With this unique window on the inner workings of the company, I became more convinced than ever that the stock was a steal and nearly doubled my position shortly thereafter.
A turnaround triumph
Turning around a large global company that has been plagued by years of mismanagement and an inbred bureaucracy is an enormous challenge and generally takes years to accomplish -- witness Lou Gerstner at IBM
I was therefore expecting that it would take at least one to two years and possibly longer before the impact of Cantalupo's changes would be felt. Yet in less than a year McDonald's has made tremendous progress and appears to have built real momentum.
That's not to say the final story has been written here, regarding either the company or Cantalupo. The turnaround is still young and it's possible that McDonald's is simply benefiting from easy comps and two hit new products (salads and McGriddles), which were developed under previous management.
I think, however, that a far more robust turnaround is under way, and the company and stock will provide at least another year or two of pleasant surprises -- which is why I have yet to sell any of my shares even after they've nearly doubled off their lows.
Whitney Tilson is a longtime guest columnist for The Motley Fool. He owned shares of McDonald's at press time, though positions may change at any time. Under no circumstances does this information represent a recommendation to buy, sell, or hold any security. Mr. Tilson appreciates your feedback at Tilson@Tilsonfunds.com . The Motley Fool is investors writing for investors .