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McDonald's, king of the fast-food burger market, has come a long way in just a year. The last three months of 2002 may have been a nadir for the company, which has struggled in recent years to keep growth strong. First, it was hit with a public backlash against high-fat foods (see BW Online, 10/15/02, "For McDonald's, the Fat's in the Fire"). In December, the chief executive resigned, and a few months after that, McDonald's (MCD
) posted a first-ever loss in the final quarter of the year. The stock hit a multiyear low of $12 per share in March.
Things have since improved, and many analysts say if McDonald's stays the course, its stock, which has soared 58% the past six months, could continue climbing smartly. It closed at $23.91 on Sept. 18, just off a 52-week high of $24 and change. That's still half of what it traded at four years ago. But Dave Kolpak, managing director of Victory Capital Management, figures it can hit $30 before yearend. "Things are going to get a whole lot better," he says. McDonald's was "going in the wrong direction for many years. Now it's going the right way." (Victory owns about 6.8 million shares, and Kolpak personally owns the stock.)
Investors liken the comeback to a baseball game that's still in the early innings. And so far, the Big Cheese of the hamburger world has done quite a few things right, including new meals, a slower expansion pace, and getting a lucky break on product tie-ins, with Disney's (DIS
) animated hit Finding Nemo scoring big with the Happy Meal crowd.
NEW McOFFERINGS. New CEO Jim Cantalupo has made the long overdue change of slowing annual store growth to about 1% to 2%, vs. the 5% or more of previous years. And McDonald's has reported several straight months of same-store sales gains in the U.S., indicating better productivity per outlet. In August, after more than a year of negative monthly performance, its Europe stores also saw a modest same-store gain of 1%.
Mickey D still has plenty to do. Being the largest player in a mature business, with strong competitors like Wendy's (WEN
) at its heels, McDonald's will never get to rest. It will take more food innovations, more cost cutting, and continued improvement in Europe. Further down the road, it'll also need to figure out how much and when to add stores in areas like Japan and Latin America, where economic growth is less-than-stellar.
While not quite culinary quantum leaps, both the McGriddle breakfast sandwich and new salad entrees are examples of fresh thinking long overdue for the Oakbrook (Ill.) burger chain. But "they have to keep new-product momentum going to keep same-store sales momentum," says Tim Ghriskey of Ghriskey Capital Partners in Bedford, N.Y. "We would want some feeling that this was the start of a multiple new-product launch. That might pique our interest in the stock." He says the McGriddle has a "unique" taste, but he questions whether it's a keeper. (Ghriskey doesn't own the stock, and neither does his firm.)
LEANER CUT. Store growth will be a smaller part of the story, McDonald's says. In 2005 and beyond, it expects sales to rise 3% to 5%, of which 2% will come from store additions and 1% to 3% from higher sales at existing restaurants. It's aiming for annual operating income growth of 6% to 7%. "Cantalupo has introduced a new level of discipline and efficiency," says McDonald's spokeswoman Anna Rozenich, adding that it's pursuing a more "realistic growth target."
A sharp focus on cutting expenses should come over the next 12 to 18 months, says Dave Sealy, senior managing analyst for consumer staples at Dreyfus. As the largest player in its business, McDonald's should have lower costs, he argues. He says Wendy's selling, general, and administrative cost is 8.7% of sales, compared to McDonald's 11%. "I see this as an opportunity down the road." (Dreyfus owns shares. Sealy doesn't.)
One possible cost-cutting target: McDonald's Partner brands -- a hodgepodge of chains that sell rotisserie chicken, Mexican fare, and other nonburger offerings. These stores added some $1 billion-plus in revenues in 2002, but lost $66 million. "You fix those losses, there's earnings growth right there," Sealy says.
Other analysts also wouldn't shed a tear to see them shut. "Those other chains are going to be gone within a year or two," Kolpak predicts, figuring McDonald's needs to stay focused on its main business. Rozenich says management is reviewing the future of this segment as part of a broad operational review.
EUROPEAN DIP. Cantalupo has already decided to reduce capital spending, which could mean a higher dividend for shareholders. Last year, McDonald's paid out $297 million in dividends. With projections of about $800 million less in capital spending, it may offer shareholders a big reward.
Kolpak says that's long overdue. Over the last five years, he figures McDonald's has paid out only 15% of earnings as dividends. That's shabby next to about the 45% other food and beverage companies paid out in the same period, he adds. McDonald's will announce details on plans for "share repurchase and significant dividend increases" this fall, says Rozenich.
Europe promises to figure largely in McDonald's bid to increase growth. "The Europe story needs some more follow through," says Pat McKeigue, analyst at Boston-based Independence Investment. He notes that one month doesn't make a trend, but with mad cow disease worries quieter and the European economies starting to rebound, he's hopeful sales in the region can improve. (The firm owns the stock. McKeigue does not personally.)
YANKEE GO HOME? Over time, some analysts think store growth could pick up again. "When the economy turns, there will be growth opportunities," Sealy says. Kolpak agrees: "They should open very selectively in the U.S. and Europe." Growing in the Middle East could be tough if anti-American sentiment keeps rising, but Asian and Latin American markets will eventually rebound, Kolpak figures.
For a giant like McDonald's, which had 2002 earnings of $893 million on revenues of $15.4 billion, keeping growth vibrant won't be easy. But if it executes its strategies, the golden arches should shine brightly for investors as well as fast-food mavens.
Tsao covers financial markets for BusinessWeek Online in New York Edited by Beth Belton
Copyright 2003, by The McGraw-Hill Companies Inc. All rights reserved.
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