History teaches us that even the most successful brands, such as Woolworth’s, which was once the largest operator of discount stores in the United States and the United Kingdom, can die. In the last year, many people have started to wonder if another iconic American brand, McDonald’s (NYSE: MCD), is beginning to die.
It is easy to see why people might think this. In the past year, McDonald’s revenue has fallen by $2.32 billion (€2.11 billion), dropping from $27.96 billion (€25.38 billion) in September 2014 to $25.64 billion (€23.29 billion) in September 2015. Obviously, no company can sustain that kind of revenue loss on a prolonged basis and survive.
The revenue losses came after McDonald’s reported that its same store sales had declined for seven straight quarters. The decline has been most pronounced in the United States, where the media has put out an almost unending chorus of bad news about the chain.
Although, it should be noted that McDonald’s is still a very profitable company that makes a lot of money. On September 30, 2015, McDonald’s reported a profit margin of 19.79%, a net income of $4.421 billion (€4.02 billion) and a free cash flow of $1.098 billion (€1 billion). These numbers alone would suggest that McDonald’s is still a very successful company, but its future is in serious question.
McDonald’s Is Not Dead Yet
The numbers show us that McDonald’s is not dead yet, but they also indicate that it could be beginning to die. The problem McDonald’s faces is what could be called the death spiral.
Currently it is a very profitable company, but it could reach a point where operating expenses exceed its revenues. When that happens, the company starts losing money and keeps losing money until it is forced into liquidation—a process American analysts like to call the “death spiral.” Whether this could happen to McDonald’s is anybody’s guess.
Some media outlets are claiming that McDonald’s turnaround is showing progress, but that improvement is not reflected in the revenue numbers noted above. The Wall Street Journal reported that same store sales at its restaurants rose .9% in the third quarter of 2015, which beat analysts’ projections of .2%.
Those increases are miniscule and are hardly indicative of real improvement. The media’s claims of a McDonald’s turnaround seem to be premature. The turnaround claims are also contradicted by some other media accounts of the company’s new initiatives.
All Day Breakfast a Nightmare?
One problem is that it is too early to see if the bold initiatives implemented by new CEO Steve Easterbrook are actually working. One of the most touted changes, the introduction of all-day breakfast at its American locations, only began on October 6, 2015. That was simply too late to affect McDonald’s third quarter revenues.
Interestingly enough, McDonald’s did see a 9% increase in foot traffic after the new menu was introduced, Yahoo Finance reported. Yet those gains could be coming at a terrible price; Business Insider reported that some of the company’s franchisees have called all-day breakfast a nightmare.
Among other problems, the new menu slowed service, lowered food quality and disrupted restaurant operations. An even greater problem was noted in this quote from a franchise operator:
“All-day breakfast is a non-starter. We are trading customers down from regular menu to lower-priced breakfast items. Not generating new traffic.”
If that quote is true, all-day breakfast could actually lower McDonald’s revenues. That is the last thing the company needs right now. To make matters worse, offering breakfast all day could increase McDonald’s labor costs:
“Unfortunately, with the current labor pool in our area, we are struggling to have enough people to run the shift, much less add an extra person,” another franchisee wrote.
It is not clear if these posts reflect the opinions of all McDonald’s franchisees, because they come from data collected by Nomura analyst Mark Kalinowski, Business Insider reported. Kalinowski interviewed only around 29 franchise owners. McDonald’s has around 3,100 franchisees in the United States.
What is troubling is that these claims tell a very different story than the one from McDonald’s itself. An unidentified McDonald’s spokeswoman told Business Insider that All-Day Breakfast was a hit but did not provide any statistics to back up those claims.
What Will It Take to Turn McDonald’s Around?
It is obvious that McDonald’s is a strong brand that seems to have a lot of life left in it. Unfortunately, it is also clear that it is going to take more than gimmicks such as All-Day Breakfast to turn the company around.
A potentially far more effective but less popular move would be the closing of poorly performing McDonald’s locations. Fortune reported that the company is planning to close around 700 restaurants this year. Such a trimming back of McDonald’s footprint might be necessary because the fast food market in some countries, such as the United States, seems to be oversaturated.
There are simply too many hamburger joints in the United States right now. In some American cities, it is possible to find two or three burger stands on the same street corner. Obviously, this situation cannot last, particularly if actual consumption of burgers starts to fall.
McDonald’s may have to close far more restaurants just to stay in business. Unfortunately, management seems to lack the backbone to take this step. The chain might easily be able to afford a round of strategic closures because it currently operates around 14,000 locations in the United States alone. The problem is that closing restaurants could scare off investors and drive down stock prices. Closing locations could also reduce revenues and hasten the onset of the death spiral.
To achieve a real turnaround, McDonald’s would need at least a year of substantial growth in same store sales. That is a growth rate of 2% or higher over several months. All-day breakfast seems to have achieved this at least briefly; unfortunately, it is too early to tell if the increased foot traffic can be sustained after the novelty of all-day breakfast wears off.
More importantly, it will need to reverse the revenue losses, which could be done by reducing its footprint. That also means the financial numbers and not the media will tells if and when McDonald’s is really turned around.
Investors would be well advised to stay away from McDonalds right now because it is too early to tell if it is a company in turnaround or a dying brand. The company’s reputation is strong as its stock price indicates, but the reputation is not translating into sales growth in the United States.
McDonald’s should also teach us that even the strongest brands can die. Investors need to pay attention to financial numbers, not a company’s name or its historic reputation. Those attributes mean little if the enterprise starts losing money.
