Don Thompson became chief executive of McDonald’s Corp. Sunday, and while he currently faces significant headwinds in all three of the company’s major regions of business for the rest of the year, McDonald’s sees a long-term path to recovery, according to a Barclays Capital analyst’s summary of recent meetings with management.
In a research note, Jeffrey Bernstein of Barclays reiterated that McDonald’s would fight off several challenges the rest of the year, including increased competition in the United States, plummeting consumer confidence in Europe, and a slowdown in growth in its Asia/Pacific, Middle East and Africa, or APMEA, division. He said, however, that initiatives in place to combat those pressures may risk comparable-sales growth in the near term but should set McDonald’s up to recover nicely in 2013 and beyond.
“The headwinds are large, though priced-in at current levels,” Bernstein wrote. “McDonald’s is not a 2012 outperformer, though we expect stabilization in the second half of 2012 and 2013.”
Taking rivals’ best shot in U.S.
The chain’s domestic same-store sales grew at slower rates of 3.3 percent in April and 4.4 percent in May, and executives indicated to Bernstein that timing and advertising of certain promotions were mostly to blame. They also acknowledged that other quick-service chains were targeting McDonald’s market share aggressively.
The most obvious example would be Burger King’s rollout of a new menu, which includes several items that have been successful for McDonald’s recently, such as fruit smoothies and snack wraps. However, McDonald’s management also conceded that recent sales lifts at Wendy’s and Taco Bell — the latter driven by extremely robust sales of the Doritos Locos Taco — would threaten its market share if the Golden Arches stood still.
However, Bernstein noted that McDonald’s likely would withstand Burger King due to the size of its marketing fund, which is an estimated five times the size of Burger King’s. Even though Burger King increased its ad spending in April and May to reach the same dollar amount as the McDonald’s marketing budget, neither Bernstein nor McDonald’s executives expect that onslaught to last.
“Management was flattered that Burger King was ‘copying its playbook,’ emphasizing that it could ‘out-gun’ and execute better than any of its peers,” Bernstein wrote, “thanks to a strong franchisee base, a believed better product, a more current asset base and faster speed of service.”
In addition to its perceived marketing advantages, McDonald’s also cited its ongoing reimaging program and product pipeline as ways to re-energize its sales growth in the United States, Bernstein noted.
Continued from page 1
He wrote that franchisee interest in the remodeling program remains high and is working for McDonald’s at the current pace of about 1,000 restaurants per year. About 40 percent of the brand’s 14,000-plus restaurants in the United States have updated interiors, while about 25 percent have refreshed exteriors, at an average cost of about $600,000 — with McDonald’s Corp. contributing about $200,000 to franchisees for reimaging.
Overall, remodeled restaurants generate a 6-percent to 7-percent lift in comparable sales over time, off a base average unit volume of $2.7 million, Bernstein noted.
“Outside of reimaging, management noted that beverage equipment was the last major product platform investment that the franchisees had made,” he wrote. “Another large investment would not be needed for at least a few years.”
As such, McDonald’s menu focus would not include launching entirely new platforms, like the successful introduction a few years ago of McCafe beverages, but rather would aim for incrementally improving current offerings. “Management remains ‘very confident’ about its product pipeline, though the focus has shifted in recent times to extending existing menu platforms and changing customer perceptions of products,” Bernstein wrote.
An upcoming promotion would be a “Favorites Under 400 Calories” menu, similar to an earlier “Wholesome Choices” promotion at.
“Interestingly,” Bernstein wrote, “management noted no impact from menu- and calorie-labeling laws passed in certain cities and local regions. In some cases, the effect has been positive, as customers realize that certain items on the menu aren’t as unhealthy as initially believed.”
Breakfast remains strong and lunch sales are picking up, management said, and getting more of the system up to 24-hour service would be a priority.
Europe austere, but strategy clear
McDonald’s four major markets in Europe — the United Kingdom, France, Germany and Russia — drive 75 percent of the continent’s operating profits and have produced a mixed bag lately. The United Kingdom and Russia have shown resilient sales, while Germany and France have slowed their growth and the rest of Europe shows severe challenges ahead, particularly Spain and Italy.
The company will focus on consistent value offerings to maintain customer counts during a time of austerity and strained consumer confidence, knowing it would have to sacrifice its margins and average check in the near term, Bernstein wrote.
Currently, the core European quick-service consumer in the 18-to-34-year-old demographic is shopping around many restaurant chains and is more loyal to a low price point than to one brand, management indicated. If McDonald’s could drive traffic now with compelling value offers and maintain it, executives noted, its European restaurants would benefit in the long run when confidence and stability return across the continent.
“Over time, the consumer recognizes that the value platform is a permanent menu addition and reverts back to their more traditional (and often higher-priced) menu favorites, while using the value platform for add-ons to the order,” Bernstein wrote, summarizing McDonald’s strategy. “The question remains how long does it last before that reversion occurs. The best guess is at least one to two quarters.”
Continued from page 2
Thus far, owner-operators in France have voted to increase their marketing spending and Spain has initiated some new value programs, Bernstein noted.
Stemming a slowdown in APMEA
Similarly to Europe, the APMEA division faces a period of slow growth due to softness in two crucial markets: Japan and China.
Japan in particular will be a drag on APMEA’s fortunes in the near future, as lowered consumer confidence and restrictions on energy usage resulting from the March 2011 earthquake and tsunami will continue to pressure consumer spending. Same-store sales fell 3.6 percent in April and 11 percent in May, Bernstein noted.
However, he added, McDonald’s guest counts and profit margins remain resilient, even if the necessary discounting and value focus are causing declines to the average check. Like other markets, Japan will keep the focus on consistent, everyday value, even as it opens an expected 120 new restaurants in 2012.
Chinese consumers also are spending less due to concerns about slower economic growth. That dynamic, combined with difficult double-digit comparisons from a year earlier, has led to same-store sales growth falling on a sequential basis every month of 2012, with May’s number coming in slightly negative.
“Importantly,” Bernstein wrote, “management believes that consumer strength has flattened rather than falling into a deep decline.”
McDonald’s 1,500 restaurants in China will meet the demand for value in the near term with a summer promotion focused on beverages, including a teatime promotion and an offering with special glassware commemorating the Olympics.
“Longer-term, management believes the business in China remains very strong and remains committed to pursuing steady development rather than reacting to cyclical economic conditions,” Bernstein wrote.
McDonald’s China will open between 225 and 250 restaurants in 2012 and will look to accelerate that pace through franchising over time. Opportunities there include bolstering breakfast, which accounts for only 10 percent of sales; building more drive-thrus, which account for about 40 percent of future openings; rolling out the McCafe program to more than the current 500 stores; and expanding delivery.