McDonald's is poised to rule fast food again

Michelin Chefs Are Signing Off on McDonald's Burgers
Michelin Chefs Are Signing Off on McDonald's Burgers

Six months after McDonald's CEO Steve Easterbrook unveiled his turnaround strategy for the business, there are signs that it's working.

US same-store sales ticked up 0.9% in the most recent quarter, the first quarterly increase in two years, and investors seem optimistic about the business going forward. Shares are up 20% this year.

The chain has been changing how it cooks burgers, adding new sandwiches and more premium, customizable burgers, and recently started offering breakfast all day, which customers have been begging McDonald's to do for years.

Meanwhile, investors appear to be losing confidence in rival Chipotle, the longtime darling of the restaurant industry, following meat shortages due to the company's strict animal treatment standards, as well as recent food contamination scares. Chipotle's shares are down almost 10% this year.

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Franchisees are less happy than investors

While investors are showing more confidence in McDonald's these days, some of the company's franchisees are telling a different story.

In a recent survey, several operators claimed that Easterbrook's turnaround plan is full of quick fixes that will only boost sales in the short term.

"Franchisees know better than anyone that the recent sales improvements are primarily from menu price increases," says Richard Adams, a franchisee consultant and former McDonald's operator.

Franchisees also complained that all-day breakfast, one of Easterbrook's most heavily publicized turnaround initiatives, is causing chaos in their kitchens and encouraging customers to trade down to cheaper menu items during lunch and dinner hours.

While franchisees acknowledge they're expecting a sales bump from the new breakfast hours, some say the sales increase won't last once the excitement of all-day breakfast wears off.

"The next few months might look pretty good for McDonald's USA but it's only window dressing and McSpin. By the middle of 2016, we may be in the tank again," one franchisee wrote in response to the survey by Nomura analyst Mark Kalinowski.

Many franchisees are frustrated because they have invested their own money into costly restaurant and equipment upgrades for the company's new initiatives, and they aren't earning enough profit to pay back their investments, Adams says.

For example, new equipment for McDonald's customizable burger program called Create Your Taste is estimated to cost operators between $120,000 and $160,000.

"They will need to see several quarters of positive results to buy into a turnaround," Adams said. "McDonald's franchisees do not make money on sales increases but on bottom-line profitability. This profitability can be diminished by capital expenditures on new initiatives or by deep discounting of the menu."

For its part, McDonald's says franchisees are excited about the turnaround initiatives.

"We're working to turn around our business with the support of our 3,100 independent franchisees, who are excited about sales drivers like all-day breakfast (which they overwhelmingly passed in a strong majority vote)," McDonald's spokeswoman Heidi Barker said. "We understand that they are reassured by our willingness to co-invest in future growth drivers."

Franchisees who are displeased won't kill the turnaround plan, though

Franchisee angst doesn't mean the turnaround plan will fail, according to Edward Jones analyst Jack Russo.

Still, Russo added, "I don't think all day breakfast is going to cure what ails them."

McDonald's still has to improve its order accuracy, speed up drive-thru service, and continue to be innovative with new products, he said.

"They have to incorporate health and wellness and even to some degree, natural and organic, into their menu," Russo said.

The new artisan chicken sandwich is a step in the right direction. A new salad would be a welcome addition to the menu as well, he said.

But there's no reason to believe the company won't be able to pull off more robust sales growth by the middle of next year, Russo said.

"There is change taking place and the franchisees don't like that," Russo said. "McDonald's is asking them to reinvest back in their business, in wages and labor, and they are not happy about that. But change had to happen at the company and they'll be happy again at some point."

Russo points to rivals Wendy's and Burger King as examples of recent successful turnarounds in the fast-food industry. Both brands have been posting quarterly same-store sales gains in the range of 2% to 4%.

"There is no reason McDonald's can't do that, and I think they will," he said.

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