McDonald’s Earnings: Struggles Glare in 2nd Quarter

McDonald’s (NYSE: MCD) investors could use a laugh, but even more so, the franchises could use laughing gas, because things are bad.
This has a lot to do with how McDonald’s treats its franchisees. It treats them like they own them, telling them to spend lots of money on upgrades and promotions, without knowing if they work.
When you combine that with shrinking sales, which are slow-cooking franchises, and the healthier and price-competitive chains like Chipotle (NYSE: CMG), you have a recipe for a really bad Big Mac.
This franchising problem is relevant as we look over McDonald’s second-quarter earnings report, released Thursday.
McDonald’s comparable store sales fell 0.7% in the quarter from a year earlier. U.S. comps dropped 2%. Thus, franchises are seeing less dollars spent in stores. It also shows us that company promotions and new products are failing, and that’s because there’s no cohesive vision around the company.
Lower comps for McDonald’s leads to lower revenues, and that means a 1% decline in constant currency revenues, but a 10% decline when factoring in the strong dollar. EPS was also down 1% in constant currency and 10% because of the strong dollar. This resulted from a 5.9% decline in operating income.

The Awful Bottom Line

The Asian region has ended its love affair with McDonald’s, as comps declined 4.5% and operating income fell a terrible 16% in constant currency and 26% thanks to the strong dollar.
Finally, we get to the awful bottom line in the second quarter, where net income fell from $1.387 billion to $1.202 billion, or 12.9%. Even though McDonald’s has about a billion dollars of cash and generates over $3.9 billion in free cash flow every year, I am hating the fact that it spends billions on stock buybacks instead of plowing that money into R&D and marketing.

Confused Management

How bad are things? If you run a franchise, you want the CEO to tell you something visionary. Something like Steve Jobs would come up with . . . and not this:

“We begin third quarter under a new structure supported by market-level focus, stronger accountability and an unwavering emphasis on the basic fundamentals of running great restaurants. We are aligning our initiatives and resources behind longer-term strategic actions with the ability to drive meaningful improvements in our business. We have talented franchisees, suppliers and employees working together to create the change needed to deliver a better experience for our customers.”

This is nothing short of disaster. This is nonsense. I’d be angry as heck. I’d want guidance! I’d want vision! I’d want sticky products and a new conception for what McDonald’s is going to be in the next few years.
That’s the problem and I don’t see it changing. Management doesn’t get it. They seem confused. They’ve spent decades resting on their laurels. Heck, even my teenage daughter noticed that Taco Bell is constantly changing its products, yet keeping a basic menu.
And yet . . . McDonald’s stock is up 0.49% this morning. I guess you can’t keep a good clown down.
Lawrence Meyers does not have a position in any stock mentioned.

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