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Burger King is resurgent, and McDonald's ( MCD -4.80% ) is feeling the heat. With shares of the Golden Arches near a four-year low, the fast-food giant introduced a bold new turnaround plan that management hopes will accelerate same-store sales growth and reestablish the company as the clear #1 in its industry. However, at first glance, investors didn't like what they saw.
The stock closed down 4.8% on Wednesday, as the market seemed to balk at its plan to spend $8.5 billion over the next decade as part of NEXT, what the company is calling its turnaround plan, which it announced at Wednesday's Investor Day. Management also gave a disappointing update on the third quarter, saying that U.S. comparable sales would be slightly negative. Image source: McDonald's.
McDonald's plan to turn the business around McDonald's has three major goals as part of its NEXT strategy. Capture 1.5 percentage points of market share gains in the chicken and beverage categories, while maintaining its leadership in beef. Expand its operating margin to the low-to-mid 50% range by 2030 Increase gross restaurant-level efficiency by 250 basis points, or about $100,000 in annual cash flow for the average U.S. restaurant.
Those are worthy goals, but they aren't going to come cheap. The company is planning to invest in its franchisees as part of the initiative with $5 billion through 2030 and $8.5 billion through 2036 for rent relief and capital support. Management believes those investments will generate a four-year payback period for franchisees, while improving customer and crew experiences.
Is McDonald's overspending? $8.5 billion is a big price tag for a turnaround strategy, and investors are often skeptical of turnaround spending, at least before it begins to pay off. Starbucks' profits initially fell at the beginning of CEO Brian Niccol's Back to Starbucks plan as the company invested in additional labor, dragging the stock down with it, but those efforts have since paid off. The company didn’t explain where the funding would come from.
McDonald's doesn't have $8.5 billion sitting on its balance sheet. In fact, it has just $4.3 billion in current assets. It could add to its $40 billion debt balance or press pause on share buybacks, which are on track to absorb $2.5 billion of its cash flow.
McDonald's spends roughly $5 billion a year on dividends, but investors should regard the dividend as safe. According to the numbers above, McDonald's will invest approximately $1.25 billion in each of the next four years, and then $600 million annually over the six years after that. That should be manageable for a company of its size.
Premium Feature Moneyball Superscore 58 /100 Today's Change ( -4.80 %) $ -12.03 Current Price $ 238.32 Will the move pay off? With McDonald's comparable sales growth wilting and Restaurant Brands International's (NYSE: QSR) Burger King ascendant, it makes sense that McDonald's would want to make a change. Burger King has revamped its Whopper, stepped up its ad campaigns, rolled out new value meals, and invested in restaurant remodels and operational improvements, and those moves have paid off.
Burger King reported U.S. same-store sales growth of 8.5% in the second quarter. McDonald's is capable of achieving a similar recovery, and with the stock now down 30% from its peak earlier this year, the stock price already reflects the company's challenges. Its price-to-earnings ratio is at a historically low 19, giving the stock plenty of upside.
At this point, I think bailing on McDonald's is a mistake for investors. The company is doing the right thing to respond to the threat from Burger King. Investing billions to return the business to growth is preferable to the alternative of a steady decline and continued market share losses to BK.
It will take time for these investments to pay off, but investors should be patient. After announcing its strategy, management deserves a chance to deliver.
Source: The Motley Fool
