What's Going on With McDonald's (MCD)?

Joel Anderson  |

It has been a rough week for McDonald’s (MCD) . Actually, it’s been a rough six months that happened to come to a head this week, but the end result is that CEO Don Thompson is out after just a little over two years helming the company. The future looks pretty bleak for the fast food industry altogether – and the iconic golden arches in particular.

What Happened to Big Mac?

So, McDonald’s has a lot of issues. But if you’re looking at why the CEO has been fired, look no further than a more-than 10% slide in the value of its stock since the start of 2012, a period during which the S&P 500 is up 60%. Given that a CEO is employed by the people who own stock in that company, it’s not surprising that Don’s getting the axe.

Sure, sometimes stock values fluctuate based on the dynamics of the stock market – meaning a company can be doing great and still see its stock suffer. However, this is not a case of “the markets are punishing a good company” or “this is a stock correction that doesn’t reflect the underlying business.” Oh no, McDonald’s is in a slump because it’s doing terribly and has been for a while.

The company’s revenue has been flat for years. Most concerning, though, is crashing same-store sales. For those of you hearing this phrase for the first time, it’s an important metric in examining retail. Basically, a store can give the appearance of booming sales and skyrocketing revenue by opening a bunch of new locations. However, if fewer and fewer people are coming back to the existing locations, it’s a sign that you’re losing customers and your brand is suffering, even if you’re boosting sales with new sites.

So, McDonald’s eroding share price is clearly associated with crashing same-store sales growth. People just aren’t choosing to eat at McDonald’s, and Don Thompson’s paying the price.

Why Did This Happen?

So, if you follow restaurant stocks, you may be familiar with the term “fast-casual dining.”

If you’re a consumer, or investor in these stocks, you already know about this and probably love it. There’s a new wave of restaurants that are offering relatively cheap food that is still of really high quality. The clearest example is Chipotle (CMG) , which pairs the convenience and price of fast food with better quality than even most of your sit-down chains.

However, if you’re someone who’s invested in either fast food chains or your sit-down restaurant chains, fast-casual dining is the name of your extinction. Basically, if you’re a fast food chain, these new eateries are offering way, way, WAY better food for only marginally higher prices and slightly less convenience. And if you’re a chain like Ruby Tuesdays (RT) or Olive Garden (DRI) , these places are way, way, WAY cheaper and more convenient…and they’re still offering better food.

On the whole, American consumers are in the midst of a food renaissance, showing a propensity over the last decade or so for eating better food. And not only have the Chipotles, Potbellys (PBPB) , and Noodles & Cos (NDLS) of the world created a market where people can spend an extra dollar on their lunch break to get something hearty, wholesome, and more delicious than a frozen, reheated burger; McDonald’s is facing competition from a variety of rapidly expanding burger chains that offer a much, much better product.

Habit Restaurants ($HABT) has already gone public and Shake Shack ($SHAK) just IPOed today, something that will has given each of them a massive influx of cash so that they can continue to capitalize on rapid growth in sales. Whataburger, Five Guys, and In-N-Out may not have an IPO on the horizon, but they are all regional powers that are squeezing out McDonald’s and other fast food chains. The strategy of lowering overhead by limiting menu offerings means they can afford better ingredients and sell vastly superior burgers at pretty comparable prices. In each case, sales growth for these chains is through the roof, demonstrating a market ready for change.

All this leaves McDonald’s holding onto the dominant share of an ever-shrinking fast food take-out bag. Prospects for future growth aren’t nearly as good as the ones for the waistlines of its regular customers, and investors appear ready to move on to fast-casual stocks just as fast as McDonald’s customers are ready to move on to those chains.

What is the House that Ronald Built to Do?

So this presents a pretty interesting issue for McDonald’s: how do they fight their eroding market share?

At first blush, the right idea might seem to be remaking their entire brand, offering quality food like the new crop of fast-casual restaurants that are obliterating their sales. They could revamp their menu to mimic those options, cutting overhead by trimming the menu offerings considerably and focusing on fresher ingredients to produce a product that people will actually enjoy eating (imagine that).

The problem there is that many of you have been reading this and thinking to yourselves “Ha! Suck it, McDonald’s! That’s what you get for offering bad food made by minimum wage workers all this time! The revolution is upon us!” McDonald’s already has a reputation that is going to be really hard to shake no matter how much they improve their quality. The image of the fast food giant as an evil megacorporation slowly killing the American public with unhealthy, low-quality food is unlikely to go anywhere, no matter what they do to counter it.

The other issue is that just as many of you have been reading this and thinking “Hey! I LIKE McDonald’s.” You’re not helping things, either. You remember new Coke (KO) ? Of course you don’t, it died a swift death at the hands of the millions of customers who had far too strong an emotional attachment to the classic Coke flavor to make that shift. Thing is, it’s not like Coca-Cola didn’t thoroughly test the new product. They had arguably improved things. But the nostalgia and familiarity of the Coke that everyone knew and loved made the shift impossible without angering millions.

McDonald’s has a number of similarly beloved household names, like the Big Mac or Chicken McNuggets. Make a major change to your core product offerings and you’re likely going to lose a huge swath of what’s left of your loyal customer base, even if you’re now offering a better product. More importantly, the odds are good you shed a lot more of those customers than you add the new, more-discerning eaters out there who already associate your brand with low quality.

So McDonald’s appears to be trapped between a broader American public that’s ready for something different and their loyal customers who probably aren’t. Do they take the plunge and risk everything in hopes of remaking themselves as a modern, fast-casual restaurant? Or do they simply accept their niche and continue making less and less money as the world moves on?

Actually, it’s option three: you buy up smaller chains that offer what you can’t.

Much was made of how, for a time, McDonald’s owned a rather large stake in Chipotle. They sold that, but that’s how McDonald’s can have its Happy Meal and eat it, too. They maintain and slowly pare down their flagship brand even as they’re buying up other chains to keep capturing the consumers who have left for more nutritious and flavorful options. If the company can buy a chain like In-N-Out (not saying they will, just a hypothetical), they can hypothetically capture both those looking for a better burger and those who just want that old, familiar stand-by of a Big Mac. Not to mention, taking a brand that’s regionally popular and simply expanding its footprint, allowing people across the country  to enjoy a product that’s already a proven success is a pretty lucrative strategy in and of itself.

Be Like the Beer Co’s

It’s exactly what beverage companies have been doing for years. Major brewers like Anheuser Busch InBev (BUD) and SABMiller ($SAB) have been snapping up smaller, craft breweries for some time. It’s really a match made in heaven for both sides. The smaller brewers get the advantages of the massive infrastructure and national distribution that would otherwise take decades to build without having to alter their product. The big brewers can maintain their existing brands for their loyal customers while simultaneously appealing to the more-discerning beer drinkers they would otherwise lose out with their diverse secondary offerings. PepsiCo (PEP) and Coca-Cola have done the same thing, offering a wide array of labels in addition to their core brands that include fruit juices, bottled water, and health drinks.

Your typical yoga-obsessed, sugar-averse soccer mom might never consider drinking a coke that’s loaded with high-fructose corn syrup, but she’ll happily drink that Vitamin Water, a brand that Coke owns and profits from. It’s strategic horizontal integration to make any corporate lackey proud.

So, is this the tact McDonald’s is going to take? Who knows? The company isn’t exactly flush with cash, and it’s likely going to have to do something to salvage its flagship brand before it can seriously consider branching out. However, I’m guessing the new CEO, whoever he or she might be, is going to have acquisitions on the brain.

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