Slow Turnaround for Fast Food Giant McDonald’s

Although expectations for  McDonald's (MCD) were low following recent U.S. comparable sales trends and external issues in international markets (food supplier issues in China, geopolitical issues in Russia), the third-quarter update paints a picture of a company struggling to keep pace with evolving consumer tastes and a competitive global restaurant landscape. The comparable sales decline of 3.3% (-3.3% U.S., -1.4% Europe, -9.9% APMEA) was in line with our expectations, though combined operating margins were a bit worse than forecast (29.7%, a decline of 330 basis points) due to temporary external factors. With management's outlook for negative comparable sales in October (which we expect to extend well into 2015), it's clear that recent menu and marketing initiatives have not had the success management anticipated.

To confront these issues, management unveiled a new global approach "to increase its relevance with customers and drive guest traffic," including a modernized restaurant experience and a comprehensive digital ordering, payments, and marketing strategy. McDonald's also outlined new initiatives designed to improve U.S. operations, including a more nimble organization with decisions made closer to the customer; revamped marketing emphasizing food quality; and a simplified yet customizable menu balancing core items and locally relevant choices. While we view each of these initiatives as appropriate, execution and timing remain questions and we believe investors should not expect an overnight turnaround.

We'll wait for additional details regarding turnaround plans before finalizing our model, but third-quarter results will likely result in a slight reduction to our $98 fair value estimate. We're also planning to review the brand intangible asset component of our wide moat and stable trend rating as well as our Exemplary equity stewardship rating, which factors in three-year cash return targets of $18 million-$21 million, but not recent execution issues.

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