No more breaks for McDonald's: analysts

But McDonald's followers said they were fed up with the latest excuses from the company, which has struggled with flat demand in its home U.S. market and a string of failed product launches since the introduction of Chicken McNuggets 19 years ago.

The Financial Post
March 23, 2002

No more breaks for McDonald's: analysts
Burger chain says profit will fall for a sixth straight quarter
Sean Silcoff

First it was the environmentalists and nutritionists who went after McDonald's Corp. Now Wall Street has decided the world's largest restaurant chain no longer deserves a break today.

McDonald's yesterday said its earnings will fall for a sixth successive quarter. It expects first-quarter net income of US18¢-19¢ a share, compared to 29¢ in the same period last year. The firm, which has over 30,000 restaurants in 121 countries and serves 46-million people each day, blamed weak economies in Asia, Africa and Latin America, the declining value of the Euro and concerns about mad cow disease in Japan.

But McDonald's followers said they were fed up with the latest excuses from the company, which has struggled with flat demand in its home U.S. market and a string of failed product launches since the introduction of Chicken McNuggets 19 years ago.

"Every quarter they have some factor affecting their business," said money manager Bill Cottrell of Ohio State Teachers Retirement System, which owns 2.5-million McDonald's shares.

"It's frustrating."

Shareholders agreed, sending the stock tumbling by US$1.05 to close at US$27.65 on the New York Stock Exchange.

Bear Stearns restaurant analyst called the news "disappointing," both from an earnings perspective and a sales perspective. McDonald's chairman and chief executive Jack Greenberg said he expected system-wide sales to increase by 6% to 7% over last year's US$40.6-billion, an improvement over the 3% growth in the first two months of the year.

"We would view McDonald's stated target of 6% to 7% worldwide system sales growth for 2002 with a dose of skepticism," Mark Kalinowski, an analyst with Salomon Smith Barney, wrote in a research report in which he lowered his earnings estimate for this year and next and maintained his "neutral" rating on the stock. "Visibility with regard to initiatives to boost the top line … remains low," he added.

Mr. Greenberg, a former Ernst & Young accountant, has struggled in his attempt to shake up the 46-year old company since becoming its fourth CEO in 1998.

At the time he promised to "reinvent the category in which we compete." But his push to have McDonald's serve freshly cooked food — instead of the burgers that sit ready to serve in heated racks — to customers has been a disappointment, adding hundreds of millions in kitchen retrofitting costs and resulting in longer lineups.

The new, fresh food, as it turns out, was not what customers expected or liked about McDonald's, and a the company's customer service ranking has declined steadily during the past seven years to the point where it now trails Wendy's and Burger King, according to a recent University of Michigan survey.

"Customer service is something I think that has more power [to improve performance] than trying to find another big hit product," said Will Ander, whose Chicago-based retail consultantcy, McMillan Doolittle LLP, has done work for McDonald's

The company's franchisees have also grown frustrated with increased restaurant openings, higher-than-expected retrofitting costs and the corporate office's decision to send out a fleet of "mystery shoppers" to check out the service.

Overseas, the company's expansion efforts during the past five years have yielded disappointing returns. The best growth prospects for the company now are much reduced expansion plans in the mature U.S. market — where it has more than 10,000 outlets – and efforts to build its recently acquired Boston Market, Donatos Pizza and Chipotle Mexican Grill chains into marketing-driven, mass-production money-factories like the core brand.

McDonald's main enemy is the demographic shift that has seen the baby boomers it grew up with eschew the chain's greasy delights for better quality and higher-priced sit-down dinners.

"What the market looks for is growth, and it's tough to grow in a mature market," said Will Ander, a consultant with Chicago-based retail consultantcy MacMillan Doolittle.

According to a McKinsey Report on the the North American food service industry in winter 2000, the "quickservice" category that encompasses fast food restaurants faces slow growth of just 1% per year during the coming decade. That is below the 3.2% annual growth foreseen for full-service restaurants and the industry average of 2.1%.

It also imperils the quickservice's ranking as the No. 1 category for food service sales, with US$123-billion in 2000, compared with US$112-billion for the full-service category sales.

McDonald's has also lagged competitors, including Wendy's, in improving the quality of its burgers and other offerings, such as salads. The company has been surpassed by the Subway chain of submarine sandwich stores, although it still boasts much higher revenue and profit.

"The further they got away from their basic burger-fries-soft drinks offering, the less successful the new product launches," says David Schroeder, a financial analyst with Dominion Bond Rating Service in Toronto. "That's what they are, and I don't think there's going to be any secular shift away from that."

On the other hand, he added, McDonald's has the best portfolio of restaurant locations in the business, and "nobody can touch them on kids" — a nod to Ronald McDonald's last remaining group of admirers.

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