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Back in the kitchen
McDonald's is all grown up. Does that mean it's through growing?
June 16, 2003: 1:37 PM EDT
By Nick Pachetti, Money Magazine

NEW YORK (Money Magazine) - On an unseasonably snowy day in April, a coterie of analysts, investors and journalists gather at a midtown Manhattan hotel to listen to Jim Cantalupo, McDonald's chief executive, present his revitalization plan.

Cantalupo, at the helm of the foundering burger giant barely 100 days, moves swiftly to the point: McDonald's is going to slice capital expenditures, rein in global expansion, raise the dividend and lower growth targets. "The world has changed," he declares. "We have to change too."

That realization has been a long time coming. With its home market saturated and the easy overseas expansion achieved, same-store sales growth has stalled and profits have fallen for two years.

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A brand once synonymous with good service and high quality is now associated with surly service and poor quality. And the nation's biggest restaurant chain has not launched a blockbuster product since 1983's Chicken McNuggets. In January, McDonald's announced its first quarterly loss since going public in 1965.

Climate change

What startled many of the attendees at that April meeting was this: Rather than trying to convince investors that it could maintain its history of powerful growth, McDonald's basically admitted that it was all grown up.

McDonald's (MCD)
Price$21.99
Current P/E16.4
Market Cap$28 billion
52-week high$30.28
52-week low$12.12
Source:www.cnnmoney.com

How did such a mighty American brand run out of steam? Throughout most of the company's life, McDonald's was unrivaled in the fast-food category. Same-store sales and store openings, in the U.S. and abroad, grew at a healthy clip -- so much so that today McDonald's remains the biggest restaurant company in the world, with more than $15 billion in sales last year.

But a decade or so ago, the climate began to change. Competitors like Burger King, Wendy's and Taco Bell started gaining ground by offering lower-priced meals. McDonald's market share peaked in 1998.

Several new product launches, including the adult-targeted Arch Deluxe sandwich, didn't catch on. And the baby boomers began choosing higher-quality "fast-casual" restaurants like Panera Bread over McDonald's.

Meanwhile, the chain suffered chronic execution problems, most recently with its failed attempt to customize orders without prolonging wait times. And relations with its franchisees, who operate 80 percent of the company's restaurants, had become strained.

McDonald's, desperate to prove to Wall Street that it could still grow at a double-digit pace, put its weight behind opening new stores, a faster and simpler way to fatten the top line than trying to boost same-store sales growth.

That strategy would prove disastrous in the long run. Today, stores cannibalize one another. Food quality remains a problem. Indeed, McDonald's came in nearly last out of 60 chains for taste and quality of ingredients in a 2002 survey conducted by market research firm Sandelman & Associates.

Cantalupo is well aware of this problem. "Trying to achieve 10 percent to 15 percent growth sometimes causes you to do things that could take your focus off the core business," Cantalupo recently told MONEY at his office in Oak Brook, Ill.

Moving the needle

What will it take for McDonald's to grow? The company's announcement that store openings would be pared back to 360 in 2003 from a high of 2,585 in 1996 was welcome news. But the key will be getting more people into existing restaurants.

It's cheaper, after all, to bring more customers into restaurants that are already up and running than to spend $1.5 million on average to build new ones. And when you have more than 13,000 restaurants in the U.S. and over 30,000 worldwide, that's the only way to move the needle.

It's a strategy that will require savvy marketing and superior execution -- core skills that McDonald's has struggled with for years. And now more than ever, McDonald's needs a new hit product. Its latest (and somewhat belated) foray into salads has fared well, but it'll take more than that to lure customers to its counters.

Cantalupo says he's got "10 ideas" he's excited about. And in a promising sign, he's turning to franchisees for their input again. It was franchisees, after all, who were responsible for many past hits, including the Big Mac and Egg McMuffin. In recent years, McDonald's was accused of relying too heavily on its vendors, rather than franchisees in the trenches, for new products.

But as far as Cantalupo is concerned, boosting the quality of the food and service takes priority over developing the next blockbuster product. "If you're not executing at the most basic level, with your food, it's hard to build on top of that," he says.

He has placed a renewed emphasis on a companywide grading system for the restaurants, and on the practice of dispatching "mystery shoppers" to report back on franchisees. Cantalupo vows that if they flunk they'll lose their stores.

The CEO is also working with advertising agencies to come up with a new, cohesive ad campaign. The timetable for all of these initiatives to work their way onto the company's top line: 18 months. In 2005, Cantalupo expects to achieve sales growth of 3 percent to 5 percent.

Cantalupo, who came out of a brief retirement in January after working at McDonald's for 28 years, is saying all the right things, according to analysts and franchisees. They note, however, that he's got very little wiggle room going into a critical juncture in the company's history.

"It's make or break for McDonald's," says Irwin Kruger, who owns seven McDonald's restaurants in New York City. Says Credit Suisse First Boston analyst Janice Meyer: "If management runs McDonald's the way it's run it, there won't be much of the company left."

It's no surprise, then, that investors have punished the stock. As the world's No. 1 restaurant chain and a double-digit grower, McDonald's used to command a price/earnings multiple in the low 20s, a premium over its peers.

At $18, it trades at 14 times estimated 2003 earnings. While April's U.S. same-store sales were up, the company has yet to show any concrete signs of a turnaround. Given the scope of McDonald's challenges and its murky future, it's best to steer clear of this stock for now.

There's a saying that generals should be judged not only on how well they advance but on how well they retreat. For most of its life, McDonald's only worried about advancing.

The company's new direction "is a big cultural change for us," says general Cantalupo. "But we're making the changes we need to make."  Top of page




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Most stock quote data provided by BATS. Market indices are shown in real time, except for the DJIA, which is delayed by two minutes. All times are ET. Disclaimer. Morningstar: © 2018 Morningstar, Inc. All Rights Reserved. Factset: FactSet Research Systems Inc. 2018. All rights reserved. Chicago Mercantile Association: Certain market data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved. Dow Jones: The Dow Jones branded indices are proprietary to and are calculated, distributed and marketed by DJI Opco, a subsidiary of S&P Dow Jones Indices LLC and have been licensed for use to S&P Opco, LLC and CNN. Standard & Poor's and S&P are registered trademarks of Standard & Poor's Financial Services LLC and Dow Jones is a registered trademark of Dow Jones Trademark Holdings LLC. All content of the Dow Jones branded indices © S&P Dow Jones Indices LLC 2018 and/or its affiliates.