In March this year, McDonald’s CEO Chris Kempczinski went viral for all the wrong reasons. In a promotional video for the new Big Arch burger, he took what could flatteringly be described as a cautious nibble. Naturally, other companies responded with their CEOs taking enthusiastic bites of competing products.
The “THIS is how you eat a burger” moment was probably beneficial for Big Arch sales anyway, as going viral is rarely a bad thing. But it unintentionally brought an important point to the fore: consumer tastes are changing and McDonald’s needs to evolve with them.
The drive-through version of the story looks like this: McDonald’s is transitioning from a period of heavy investment in tech and system rationalisation to an era of providing financial support to franchisees for restaurant remodels. If Kempczinski could get through these strategic mouthfuls at the latest Investor Day, it’s hard to imagine how he didn’t cope with a Big Arch.
The market isn’t finding much to laugh about here. The share price is down more than 21% this year after hitting a four-year low during the event. The five-year share price CAGR (compound annual growth rate) is 0.1%, with those crumbs being supplemented by an average dividend yield of around 2.2% per year over the period.
Can they change this trajectory?
It won’t be easy, with McDonald’s expecting flat industry traffic over the next few years. This means there will be a bitter fight over market share, with Kempczinski putting it eloquently: “The winners will be the companies that create more demand and deliver it more efficiently”.
Goodness knows they have a large-enough customer base. As pointed out at Investor Day, if the 90-day active loyalty base of 220-million customers were a country, it would be the seventh largest in the world. It’s easy to forget just how big McDonald’s really is!
As anyone who follows consumer stocks will know, data on customers is a critical enabler of personalisation and re-engagement opportunities to drive sales. Digital adoption trends vary by region, with China the clear standout at an astonishing 98% of sales being initiated on a device.
But the data only gets you so far. People actually need to like the product, with more health-conscious consumers wanting to understand what they are actually eating. More protein and less rubbish is preferred.
The Investor Day included a very cheeky stat, with McDonald’s noting that 10% of US adults are on GLP-1s and 84% of households with GLP-1 users are visiting McDonald’s. Sure, but there’s a vast difference between “adults” and “households”. Also, a customer who now buys a small burger once a month versus a large McFeast meal every Friday is a very different customer, but is still “visiting” McDonald’s. The market is smart enough to see through that kind of nonsense.
The most compelling story is that McDonald’s has an opportunity to increase market share in chicken and beverages, categories that are nearly three times and five times larger than beef respectively. McDonald’s has more than 40% market share in beef, but only high teens in chicken and high single digits in beverages. It may shock you to learn that McDonald’s is the second-largest coffee player globally!
The beverage opportunity is most interesting, as these are high-margin and easy-to-execute products. With more than half of beverage-led visits being after lunch, this helps drive sales throughout the day.
McDonald’s is promising an increase of 1.5 percentage points in market share across chicken and beverages, showing how hard it is to really move the dial. But the spicier promise is 250 basis points of gross margin efficiency at restaurant level.
Achieving that margin uplift will require a remodelling programme, with restaurants being enhanced across the drive-through, play area and beverage preparation areas. Visible beverage preparation is highlighted by management as a way to build customer trust.
This comes at a serious cost. A remodel in the previous style cost around $400,000 in the US, or roughly a year of cash flow for a franchisee. The new design is double that cost, but only provides a $100,000 uplift in annual cash flow. It’s a big ask for franchisees, with McDonald’s stepping in to offer rent relief and capital support of an estimated $8.5bn over the next 10 years.
An indicated payback period of five to six years for McDonald’s for each restaurant remodel just didn’t hit the spot for investors. The golden arches were a pioneering force in fast food, but the world just isn’t what it used to be.
