McDonald’s Turnaround Plan Takes a Page from Wendy’s Playbook

Shares of fast-food restaurant Wendy’s (NYSE: WEN) are up an impressive 165% over the last five years, leaving the largest fast-food burger company, McDonald’s (NYSE: MCD), in the dust. Over the same five-year period, shares of McDonald’s are up just 43%.mcdonald's-wendy's

But for all the success that Wendy’s has had over the last half-decade, is there a better play for the next few years? Well, the short answer is, yes.

Wendy’s has had a stellar run, but sometimes a growth story gets played out. Even Wendy’s top shareholder, Nelson Peltz’s Trian Partners, realizes this. The hedge fund, which has had a large stake in Wendy’s for a decade, recently decided to shed some shares. Trian Partners ultimately plans to reduce its stake from 24.8% to between 17% and 20%.

What has driven Wendy’s stock price and earnings growth over the last few years has been its aggressive remodeling and refranchising plans. However, that catalyst is starting to wear thin. The fast-food company is getting close to its target of owning just 5% of its stores. It expects to sell close to 400 stores this year and then just over 250 in 2016.

Yet, another major fast-food player could be looking to embark on a similar strategy. McDonald’s plans to refranchise up to 3,500 stores (its previous target was 1,500) by the end of 2018, which would reduce administrative expenses and shift the burden of capital expenditures from the company to franchisees. This would help get company-owned stores down to 10%, but it would still be a ways from Wendy’s current model.

The other key catalyst for McDonald’s turnaround plan is increased franchising in China. About 15% of Chinese stores were franchised a couple years ago. McDonald’s thinks it can get that number closer to 25% in the near term.

But the company still has fundamental problems in terms of resonating with customers. Its “unhealthy” food menu is working against it. Even still, as I noted in January, McDonald’s has undergone “tough times” before. Recall that McDonald’s stock went from over $45 a share down to the low teens in just two years during the early 2000s. But as it did then, a turnaround is possible; it just takes time.

Along those lines, McDonald’s laid out its turnaround plans last month. However, the plans weren’t as “clear” as much of the market would have liked – hence the muted increase in the stock price. But it’s a solid start.

McDonald’s will also be revamping its segment reporting. It will shift from geographical reporting to a system that includes breaking its stores into such categories as high growth and foundation. This should refocus management’s attention to markets that are generating the most profits.

But the big near-term catalyst is the streamlining of its menu. This includes catering menus to local and regional taste preferences.

The other piece of the puzzle is shareholder returns.

Wendy’s has a $1.4 billion buyback plan in place through 2016, but most of that will be completed via a tender offer over the near term. McDonald’s recently renewed its commitment to shareholder returns, noting that it’s less concerned with its single-A debt rating and more concerned with getting money into shareholder pockets. The key is that McDonald’s still plans to maintain a solid credit rating, but won’t be concerned with the vanity of having a high rating.

McDonald’s pays a 3.6% dividend yield and has a 38-year streak of consecutive dividend increases. That dwarfs Wendy’s 2% yield and three-year dividend increase streak.

McDonald’s has the key initiatives in place to drive earnings growth, allowing it to turn its focus toward branding. With its scale and installed base of franchisees, the company can still keep investors happy with shareholders returns as it works its turnaround.

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Published by Wyatt Investment Research at