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BERKO: Do you want fries with that?

DEAR MR. BERKO: My 16-year-old son has saved up over $6,000 in the past two years from part-time jobs and wants to invest this money. He has done some research on the computer, and his investment of choice is McDonald’s. I also looked it up and read that the company’s revenues and earnings are falling and have been for several years. My son did a lot of work on this stock and compiled 37 pages of research and articles about the company. I don’t want him to make a mistake. How can I tell him he’s wrong without stifling his initiative? — PM, Jonesboro, Ark.

DEAR PM: Don’t! Even the most successful businesses are subject to cyclical headwinds from time to time, and McDonald’s (MCD-$90) has never been an exception.

Yes, McDonald’s does have problems. After impressive revenue and earnings gains between 2005 and 2011, a 40 percent improvement in operating margins and global sales growth averaging 5.5 percent, management has gotten a bit too cocky and may have lost its way. Same-store sales, or SSS, in the U.S. crashed 4.6 percent, far more than Wall Street’s expectations of 1.9 percent — its largest slide in SSS since 2000. And MCD’s problems are not just in the U.S., because global SSS declined 2.2 percent, versus analysts’ projections of 1.7 percent. Food price volatility, higher labor cost and foreign currency fluctuations are hurting MCD’s quarter-to-quarter results. And when reading the restaurant’s bloated menu, you’d think you’re in a Chinese restaurant. It can take 10 minutes to decide what to take home for a family of five, which contributes to terrible service. And you’re never sure whether the tattooed kid at the counter took your order correctly. When you get home, you’re usually missing an order of fries, or there’s no cheese on your Big Mac but there are pickles on your cheeseburger. Revenues are also hurt by price wars among the major fast-food service restaurants, plus the lure of newer entrants, such as Five Guys, PDQ, Chick-fil-A, Jimmy John’s, Zaxby’s and Firehouse Subs. MCD’s U.S. president, “Big Mike” Andres, commenting on MCD’s dismal revenues in a recent email to franchisees, said, “The reality is that our current U.S. structure is not optimized for the customer.” Big Mike is going to optimize to make MCD well again. Darn and I’ll be a son of a biscuit, what does “optimized for the customer” mean? If Big Mike also talks like that in his conversations with franchisees, I’d never want to own a franchise.

MCD has had slippage in the past, and that’s as normal as rain, which is always followed by sunshine. The Marines have a saying: “When things get tough, the tough get going.” And MCD is one tough cookie, so don’t make the mistake of ascribing long-term consequences to short-term events. MCD will prevail, beginning with new initiatives improving U.S. operations, including a more flexible franchisee relationship, an emphasis on food quality, a simplified, customizable menu that also improves MCD’s glacial service, and a customer-centric marketing campaign that appeals to a broader range of consumers.

And an industrywide change that will reduce costs, quicken service and improve order accuracy is on the way. Customers will soon be ordering by tapping on a touch screen to create their own burgers. MCD expects to install these touch screens in 2,000 of its 14,000 U.S. restaurants in 2015 and 2016. The average McDonald’s generates about $2.5 million in annual revenues, and the touch screens easily will eliminate four to six employees, reducing labor costs by over $110,000, or about 4 percent, annually.

Those and other changes suggest that MCD can return to the lower end of its long-term goals: sales growth of 3 to 5 percent, operating income growth of 6 to 7 percent and 17 to 19 percent returns on incremental invested capital. So considering MCD’s impressive, worldwide brand recognition, its 14,000-plus high-traffic, well-selected locations, its history of providing a good customer experience, its locally relevant menu choices, its interior and exterior physical plant renovations, its more efficient kitchens, and the fact that an average of 1,400 new locations will open annually, MCD will prevail. I think your son has done his due diligence well.

Please address your financial questions to Malcolm Berko, P.O. Box 8303, Largo, FL 33775, or email him at mjberko@yahoo.com

 

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