McDonalds showing serious signs of being dead in the water

By Steve Brachmann
May 15, 2015

mcdonalds-335It would be an understatement to say that, currently, McDonalds (NYSE:MCD) is not lovin’ it. The most recent quarterly earnings report from the company headquartered in Oak Brook, IL, showed that the company suffered a year-over-year loss in earnings per share from $1.21 to $1.01 per share. Profits at the company tumbled 30 percent in the first quarter of 2015, a poor showing after a couple of years of diminishing returns. The company has already shuttered hundreds of locations worldwide this year due to dwindling sales and public outrage over food quality scandals in Japan and China.

Also hurting McDonalds is the increasing value of the American dollar. As an international business located domestically in America, McDonald’s profits, much like many other multinationals, are squeezed off because of reduced foreign sales and the foreign currency it earns is worth less in its home country. However, McDonalds specifically is going through some pretty major organizational issues that make food quality concerns pale in comparison. Net income for the company has dropped by 36 percent over the course of a year, from $1.2 billion in 2014’s first quarter to $811.5 million in the most recent quarter. The international company is also facing a drop in operating income of 28 percent worldwide, 11 percent in its native U.S. market. Same-store sales have been dropping all over the world, indicating that consumers are turning away from the brand for better food options. A brand survey on consumer perceptions including food quality conducted recently by Nation’s Restaurant News ranked McDonald’s 110th out of 111 limited-service restaurant chains, only beating Chuck E. Cheese’s.

In response to all of these body blows to McDonalds, CEO Steve Easterbrook announced a number of changes that he hopes will set the corporation on a much more successful course. Easterbrook promised investors after the earnings report was published Wednesday that the company would be making meaningful changes to its menu within the month. Easterbrook has also proposed a major restructuring to the corporation’s global operations that would split the company into four segments: one focused on lead markets like Britain and Australia, a high growth division including Russia and China, a U.S. domestic division and one focused on McDonald’s activities in the 100 other countries where the fast food restaurant operates.

The main corporation also wants to divest itself of some 3,500 restaurants to franchise owners, reducing the percentage of McDonald’s restaurants actually owned by the company from 19 percent to 10 percent. Easterbrook has already stated the “urgent need to reset this business” and franchising nearly one-tenth of all McDonald’s operating has the appearance of seeking cover during a heavy storm even if Easterbrook sees the company’s forecast clearing up in the future. Then again, as we’ll point out later, maybe the company isn’t going far enough in that direction in this respect.

Many franchise owners are already livid by a number of the changes made by the company in recent years. A restaurant survey conducted by Mark Kalinowski, a financial analyst with wealth management firm Janney Capital Markets, reflected the worst rating given the company by franchise owners in 11 years, only 1.81 points on a 5-point scale. The survey represents the views of less than one percent of the company but that small percentage has been pretty vocal about its anger towards the main corporation. Even if the survey only serves as a vehicle for a small corporate minority to grandstand, comments like “I’m selling my McDonald’s stock” and “There is no leadership, no plan, no respect for operators or their investment” must be discouraging to some; those survey quotes were reported by Business Insider.

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This vocal minority has plenty of targets at which to aim when talking about reasons why owning a McDonald’s restaurant is not the prime investment that it used to be. In response to a nationwide movement seeking a $15 an hour wage for fast food workers, McDonald’s has committed to raising the wage for workers at corporate-owned locations to more than $10 per hour by 2016. The pay raise will only be issued to the approximately 90,000 McDonald’s workers working directly for the company and not for franchise owners. Franchise owners worry that they’ll be pressured to raise wages, adding additional costs to a business that’s already trying to incorporate more digital technology at store locations and new upscale food options like sirloin burgers.

All of this could mean that, currently, we’re watching a McDonalds corporation that’s falling like the Roman Empire. Brand perception is incredibly low and same-store sales are dropping. Investors want out. Costs are building. If someone with capital wants to enter the fast food business, McDonalds is likely the last place they’re looking to go. Aside from the global restructuring, which will have to show proof of success before it can be judged a successful business decision, it could be argued that Easterbrook is managing the situation about as well as Nero with the violin, watching the company’s profits burn to ash while fiddling with the public image of the Hamburglar. No company is going to be able to function after having lost the confidence of its customers, employees and investors. After that, who’s left?

The corporate history of America is dotted with the slow and sometimes painful decline of former giants. Regular readers of IPWatchdog’s coverage may be familiar with our profile of Kodak, a company demolished by its own invention: the digital camera. The word processing equipment produced by Wang Laboratories was used at 80 percent of America’s 2,000 largest companies in the early 1980s and yet the company was so crushed by its decision to stay out of the personal computing market that this writer had never once before heard of Wang computers. Some incredibly thorough research by Brian Sozzi of Belus Capital Advisors has lighted upon the massive corporate struggles facing Sears, a retail corporation which announced in 2014 that it would be accelerating store closures. Interestingly, technology plays at least a minor role in this story as well as Sozzi points out that technologies used to improve the consumer experience at Sears stores are greatly outdated compared to former competitors like Macy’s and Home Depot, heavyweights that are now in a different class than Sears entirely.

Some point out how Easterbrook’s restructuring plans resemble some of Burger King’s successful turnaround methods. After that company was sold to Brazilian private equity firm 3G in 2010, most of the 12,174 Burger King restaurants owned directly by the company were franchised, leaving the main corporation with only 52 company-owned locations. Of course, if you believe that a big problem deserves a big answer, franchising 3,500 locations and retaining 10 percent of stores as corporately owned seems a bit bland by comparison.

A quick look at the requirements for succeeding in the fast food business show us just how much of an uphill battle that McDonald’s has to wage in order to once again become a feared warrior in the fast food market. As Forbes has pointed out, current consumer trends indicate that successful fast food chains provide customizable food options, are transparent about their food sources and offer healthy menu options. McDonald’s has a Favorites Under 400 menu for calorie counters, launched it’s own food transparency campaign last October and still can’t stop its dwindling sales. Obviously, either what’s tried and trusted for the fast food restaurant industry isn’t working for McDonald’s or the company hasn’t gone far enough yet to deliver what fast food restaurant customers truly want.

McDonald’s is not yet a dead horse, so if we’re able to beat it just one more time, we should point out that, much like Kodak, McDonald’s gave life to the entity that may become the company’s undoing: Chipotle (NYSE:CMG) and the fast casual dining experience it has come to epitomize. The burrito chain had just over a dozen stores in 1998 when McDonalds decided to take a minority stake in the company and increased its investment, enabling Chipotle to expand to 500 locations by 2006. McDonald’s divested itself of its Chipotle holdings in that year, selling out for $1.5 billion in an effort to focus on its core business as a burger flipper. Chipotle stock has risen from around $40 per share in 2006 to $633.82 per share as of this writing and Chipotle’s current market cap is $19.52 billion.

The worst part about all of this isn’t that McDonalds left Chipotle before it became massively profitable. The worst part is that Chipotle has accomplished this feat by being the anti-McDonald’s. There is no company in the casual dining market whose practices are so different than the operations going on under the Golden Arches: as Bloomberg Business points out, Chipotle doesn’t operate drive-thrus, invests much more money into food, doesn’t have a breakfast menu, doesn’t franchise locations and tasks employees with many more food preparation tasks, like chopping tomatoes.

Easterbrook could very well get his business reset that he’s seeking, the one he thinks McDonalds desparately needs. It’s just that to reset anything, you have to turn it completely off for at least a moment. Will McDonalds have the battery power to turn it back on once all of its power goes away? We’ll wait and see.

The Author

Steve Brachmann

Steve Brachmann is a freelance journalist located in Buffalo, New York. He has worked professionally as a freelancer for more than a decade. He writes about technology and innovation. His work has been published by The Buffalo News, The Hamburg Sun, USAToday.com, Chron.com, Motley Fool and OpenLettersMonthly.com. Steve also provides website copy and documents for various business clients and is available for research projects and freelance work.

Warning & Disclaimer: The pages, articles and comments on IPWatchdog.com do not constitute legal advice, nor do they create any attorney-client relationship. The articles published express the personal opinion and views of the author and should not be attributed to the author’s employer, clients or the sponsors of IPWatchdog.com. Read more.

Discuss this

There are currently 8 Comments comments.

  1. Bob May 15, 2015 9:30 am

    “year-over-year loss in earnings per share from $1.21 to $1.01 per share”

    That isn’t the proper way to use those words. A decline in EPS is not a ‘year-over-year loss’.

  2. Tom May 15, 2015 9:40 am

    Seems unnecessarily wordy and to lack some basic finance knowledge. The best example of this was the suggestion that someone with capital could come in and buy McDonalds. Their current cap is $93.55B and a takeover bid would likely have to exceed that.

    So Apple’s $137.1B in cash could do it. No other publicly traded company has the assets necessary.

  3. Gene Quinn May 15, 2015 9:46 am

    Tom-

    Your comment seems to lack basic finance knowledge as well. You seem to misuse the word “asset” when you say that no publicly traded company other than Apple has the “assets necessary.” Your comment seems to conflate the term “asset” with there term “cash on hand.” You are clearly wrong to say that there is only a single company with the assets necessary.

    -Gene

  4. Night Writer May 15, 2015 10:53 am

    I think McDonald’s stop marketing themselves. Really, they have the platforms to serve pretty much anything that any fast food restaurant can. But, they haven’t been fighting back with commercials to counter all the unhealthy comments. They have become the whipping boy of the fast food restaurant.

    They need marketing and minor readjustments. “You deserve a break today…”, “Two all beef patties, special source …”, etc.

    #whathappenedwiththeirmarketing

  5. Night Writer May 15, 2015 10:55 am

    >>If someone with capital wants to enter the fast food business, McDonalds is likely the last place they’re looking to go

    This seems a bit premature to me. They are still the 800 pound gorilla.

  6. Steve Brachmann May 15, 2015 11:21 am

    @Night Writer – McDonald’s is an 800 pound gorilla in this market, true. There are just a lot of reasons to be discouraged by its current business model. If I had resources and wanted to enter the fast food market, I would be looking at the success of fast casual establishments like Chipotle and try to operate a business based at least in part on their model. Chipotle’s revenues are growing while McDonald’s are underperforming according to some financial analysts and as we’ve pointed out, the two businesses couldn’t be more different. This death knell is coming early, yes, but with employees/customers/investors all unhappy, who is left? Unless there’s a major fix sometime soon that goes beyond a milquetoast version of Burger King’s restructuring, it looks like the writing’s on the wall, it will just be a very slow decline for this 800 pound gorilla.

  7. Night Writer May 15, 2015 11:30 am

    Maybe you are right Steve. Maybe they won’t be able to adapt fast enough or market their way out of it. But, they still have some time to try before I am willing to write their epitaph.

  8. Gene Quinn May 17, 2015 7:56 pm

    Due to an abnormally large number of spam comments on this article comments are now closed.