McDonald's (MCD) new CEO, Steve Easterbrook, outlined the first steps to a turnaround at the company on Monday. This focused on a return to relevant menu items, better service and lower costs through the adoption of technology.
Even though the company had been pretty clear that the meeting would focus on the operational aspects of the turnaround, some had hoped it would also step up with an aggressive financial re-engineering as well. When this did not occur, there was a modest disappointment and the stock sold off.
While the company didn't identify a silver bullet to fix their business, they did lay out a well-thought-out framework to return MCD to the forefront of the fast-food industry. The most meaningful part of the announcement was that McDonald's was going to be reorganized into four new global segments for greater level of accountability: United States, international lead, high growth and foundational markets.
The company also said it was going to increase the refranchising of operations from a current level of 81% to 90% over the next three years. Besides freeing up capital, this initiative will also save money and push operating responsibility to more entrepreneurial franchisees to drive higher growth at the company.
The operational reorganization and refranchising should allow McDonald's to reduce operating costs by $300 million to boost company margins.
Many investors who had hoped for more were underwhelmed by the announcement. However, Easterbrook stressed during the call that this was the first level of the turnaround. The company will be experimenting with new menu items, service levels and technology in the coming year. As this operations-focused strategy progresses, further programs will be adopted to aid in the business fix.
While nothing announced was Earth-shattering, we did get a strong sense that Easterbrook understood the magnitude of the problems the company is facing. Furthermore, he had an absolute sense of urgency that things needed to be fixed sooner rather than later and was prepared to do whatever it takes to improve all aspects of the business. The fact that Easterbrook had previously fixed McDonald's Great Britain operations and then Europe gives us great confidence that he is the right person for the task of fixing the company on a global basis. We had been underwhelmed by the last CEO and have much greater confidence in Easterbrook and believe this new leadership will be a catalyst for positive change.
Beyond the operational turnaround plan, we ultimately expect McDonald's to be more aggressive in its financial re-engineering. This could include more aggressive cost cutting, further increases in percent of franchises, monetization of extremely valuable real estate assets and returning more cash to shareholders through an aggressive share buyback. We would expect the company to more actively pursue some or all of these actions as the operational turnaround starts to pick up steam.
On the call, the company did up its expected returns of cash to shareholders in 2015 to $8 billion to $9 billion vs. a previous estimate of $6.3 billion. While not a needle mover, it does show the new CEO's commitment to shareholders.
In light of the new urgency to fix itself, we are looking for good things from MCD in the coming year and would be buyers here. We are not expecting monumental things from the company, but we do believe the stock has 10% to 20% upside over the next 12 to 18 months, and investors are paid a 3.5% dividend yield while they wait for the turn. We think the stock has the added plus of providing downside protection in the event of market pullbacks due to this attractive dividend yield.
We believe the combination of better execution, a better menu, greater executive accountability and managing cost structure along the way will lead to better things for the company.
At the time of publication, Katz was long MCD, although positions may change at any time.