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5 ways McDonald’s can turn its business around

April 21, 2015, 3:21 PM UTC
McDonald?s Profit Climbs 4.8% As New Menu Items Drive U.S. Sales
McDonald's Corp. chicken selects, a McCafe coffee, iced caramel mocha and strawberry banana fruit smoothie are arranged for a photograph in San Francisco, California, U.S., on Friday, April 20, 2012.
Photograph by David Paul Morris — Bloomberg via Getty Images

McDonald’s founder Ray Kroc once said: “If you’re not a risk taker, you should get the hell out of business.” As the restaurant chain struggles, there has never been a time in the history of the company where following the advice of its legendary founder has been more critical than it is today. Under the direction of new CEO Steve Easterbrook, McDonald’s (MCD) is expected sometime between now and the beginning of summer to unveil plans to turn the company around.

Analysts have been talking about several scenarios. And while it remains to be seen what could happen, the following are my thoughts on a few ideas floating around Wall Street.

Scale back the sale of espresso-based beverages

The number one priority is to reset the sales trends in seven key global markets. Returning these markets to positive same-store sales growth will result in the greatest creation of shareholder value. We will wait and see what the company plans to do, but the overarching theme is that McDonald’s must focus on the mantra, “shrink to grow.” In other words, the chain must make a concerted effort to shrink its menu.

In the U.S., this will likely call for the elimination of what I consider the most expensive mistake in the history of the company: espresso-based beverages. It costs franchisees about $100,000 per store to implement the McCafe models and the sales of espresso-based beverages are running well below the intended sales targets. It’s time for McDonald’s to focus on being itself, instead of pretending to be something it is not (i.e. Starbucks.)

Don’t get into the real estate business

Wall Street seems obsessed with the notion that the company will enhance shareholder value by leveraging its balance sheet or forming a Real Estate Investment Trust (REIT), which by law must pay out at least 90% of taxable earnings to shareholders as dividends. As advantageous as this sounds, it’s unlikely to happen. Taking on additional leverage while margins are declining will put unnecessary pressure on profitability and will perpetuate unnecessary financial risk. There should never be a McREIT!

Cut administrative costs

There is an opportunity for McDonald’s to cut its general & administrative expenses. This will be the biggest challenge for the new CEO. It will be critical for Easterbrook to make bold changes in inefficient and unnecessary operational areas. While some of the cuts will fall to the bottom line, the company must better maximize its resource allocation (human capital and financial resources) and re-invest in the business to bring the company back to life.

Address franchise concerns

The new CEO must reestablish the company’s connection with its owners/operators.

Given how much the business of advertising has changed since McDonald’s was founded in 1940, the critical issue facing the new CEO is how to make its voluntary cooperative of owners/operators, known as OPNAD (Operators National Advertising Fund), more effective. McDonald’s and the owner/operators combine their marketing dollars to fund national television advertising. Given that OPNAD was formed in 1967, the question is should the company restructure how it purchases media?
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For many years, every store paid 1% of sales into OPNAD plus another 2% to 3% locally. This fee fell to 2% in the early 1990’s and to around 1.6% today. With a more regional approach to marketing, that probably needs to come down further, and the franchisees are talking about bringing some money home to spend locally.

Ramp up mobile ordering

While the broader restaurant industry has been working hard to adopt mobile ordering, McDonald’s has been slower to catch on.This illustrate just how behind the company is in terms of innovation.

This is a real black eye for the company and especially the Board of Directors. The company recently said a global app should be ready to launch in the next few months, though the launch date and exact functionality of the application will be up to McDonald’s management in each country. The app will likely roll out in the U.S. sometime this summer.

We hope there are better days ahead for McDonald’s and look forward to seeing what the new Golden Arches will look like. But until then, the company is still struggling to find its way and the stock will tread water.

Howard Penney is a managing director at Hedgeye Risk Management, a Connecticut-based research investment firm. He heads the firm’s research over the restaurant industry. Penney does not own shares of McDonald’s. Follow him @HedgeyeHWP