It is safe to say McDonald's(NYSE:MCD)had a bad year in 2014. The fast food giant seemed to face a new negative headline each week. It suffered through a food supply scandal in China, a fiercely competitive environment at home, and declining sales across the board.
Not surprisingly, the constant flow of bad news took a toll on the stock, which has underperformed the market for several years now. In light of all that has gone wrong, it is becoming increasingly difficult for investors to hold onto their shares. And yet, despite its poor performance, here is why I am sticking with the Golden Arches.
Patience is the necessary ingredient
First, the strategies McDonald's has implemented do show promise. The "Create Your Taste" initiative allows customers to build gourmet burgers with specialty ingredients, capturing the highly successful customization trend mastered by Chipotle Mexican Grill.
In addition, McDonald's is focusing on value, not just on price. Lowering prices is no longer a viable strategy as rising food costs have inflated expenses and eroded margins. Operating margin fell almost 3 percentage points last year to 29%. In response, McDonald's is testing out new, upscale store concepts that offer better food, albeit for a higher price, in select international markets. If the concept catches on, margins could see improvement with a wide rollout of the concept.
Investors must keep in mind these measures will take time and resources before seeing results. McDonald's is still the largest fast food company in the world with more than 36,000 locations across the globe. A company this size, with an enterprise value of $100 billion, cannot turn on a dime. It takes months for strategic initiatives to reach the bottom line, which is why management urged patience in a recent presentation to investors.
In its fourth quarter earnings release, McDonald's warned that business conditions will remain weak in the first half of 2015. Also, the company will be less aggressive in opening new restaurants than initially planned. Management cut its capital expenditure budget to the lowest in five years as it seeks to execute on plans already in place and focus on improving the customer experience at existing restaurants. CapEx will come in at $2 billion in 2015, down from $2.7 billion last year.
And there is good reason to focus on existing locations. Comparable sales, which measures sales at locations open at least one year, fell 1% in 2014 as a result of reduced traffic. McDonald's is now emphasizing better ingredients, renovated restaurants, and a faster service experience. In recent years, an overly complicated menu did little but slow service, and the company has plenty of room to improve its public image before returning to aggressive restaurant growth.
Shareholder rewards remain intact
Put simply, the main reason I have not given up on McDonald's is the value proposition the stock still offers. Despite the problems, McDonald's remains highly profitable. The company generated over $4.7 billion in earnings last year amid lower comparable sales.
This illustrates the true power of McDonald's underlying business, that it can endure so many body blows and live to fight another day. Even though comparable sales are falling, McDonald's enjoys tremendous scale and brand power. And there is still a lot of potential behind the turnaround, an idea that gets little credence in the financial media these days.
With these earnings, McDonald's showers investors in cash. The Golden Arches returned $6.4 billion to shareholders last year in combined dividend payments and stock repurchases. This was in line with management's broader goal of returning between $18 billion and $20 billion to investors from 2014 to 2016.
It might take time, but the strategic initiatives being implemented with a new CEO at the helm could make 2015 much brighter than 2014. In the meantime, the 3.7% dividend yield, strong balance sheet, and powerful, global brand keep me from selling the stock just yet.