McDonald's Bear's Den
by Rick Munarriz ([email protected])

Earlier this month Nicaragua welcomed McDonald's back after an eleven-year absence. It was a cause celebre as the lines circled the block for a Big Mac fix. The country's Vice President, Enrique Bolaņos, declared it a victory now that foreign investors would see the golden arches and tread carefully back into the country once under Marxist rule.

This scene has been repeated over and over in more than 110 different countries. It makes you want to well up as an American. You're not American? Well I'm sure there's a McDonald's from where you hail. The globe is only so big, and there are only so many new places for the Chicago-based company to go.

So let's take reality out of the fry basket and let it drip dry. McDonald's is a great brand, but unless you're a Nicaraguan elected official, it's a brand in distress. A survey cited in Business Week ranked McDonald's quality 87th out of 91 fast-food chains. Nicaragua is happy, but the citizens would have been better fed by 86 other U.S. chains. That is not a sound endorsement.

The company has tried to address the consumer displeasure, from tinkering with the food preparation process to introducing new items, but the sad truth is that McDonald's is the largest chain not because it's better, but because it was the fastest. Who cares, you say? I say wait until you see the growing pains really kick in and more than 23,000 units worldwide begin to add weight to this daunting bench press.

I want to key in on the domestic issues, but since half of the units are now overseas let's take a quick look abroad. Ready? A world tour in three words -- rising dollar, bad.

Okay, stateside again we see that the last few years of perpetual same-store sales decreases may have been temporarily averted thanks to the Teenie Beanie Babies promo. For that two-week span sales were up 25-30%. Nice, hang the future of a multibillion dollar empire on a fad. The news reports of patrons scooping up Happy Meals and tossing away the food contents at the time were not kind. We're Number 87! Believe it.

While on the surface the partnership with Disney <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: DIS)") else Response.Write("(NYSE: DIS)") end if %> seems wonderful, consider that the studio's strength, animated films, peaked four years ago with The Lion King. Catch the poor Mulan or Armageddon box office lately? The lion sleeps tonight. Disney's Animal Kingdom opens to anemic crowds and Mickey D's brings back the McRib. Oh, golden, celebrate an empty zoo by serving a pig in its blandest form.

McDonald's just doesn't get it. The company is taking a $235 million charge for layoffs and implementing a state-of-the-art order processing system. Where is the originator's spirit that was Ray Kroc? Doing what every other chain like Wendy's <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: WEN)") else Response.Write("(NYSE: WEN)") end if %> and Checkers <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: CHKR)") else Response.Write("(Nasdaq: CHKR)") end if %> is doing is not going to bring back the magic. Sitting under a heat lamp for a few minutes more is not what kills McDonald's, nor is it the ketchup to salt ratio. What kills McDonald's is that it has been leaning on those golden arches for way too long.

They are the only ones who don't laugh when the words, "Did somebody say McDonald's?" are spoken. They are stuck with that $0.99 promo price point and decide to sell a bigger burger. Minimum wage gets bumped up from $4.25 to $5.15 and they continue to cannibalize by expanding in robust job markets. Under the bright "Billions Swerved" sign, in tiny print, look for the Falling Margins disclaimer. It's there, and while Kroc has passed away, crock is alive and kicking.

This would be a problem even if the stock were stuck below $55 during the aptly named and aptly failed Campaign 55 promotion the year before. But the stock has finally broken the speed barrier and the jaded come with radar guns.

Let's look at the analysts before we deep fry them. They are an optimistic lot and they expect the company to earn $2.51 a share this year and $2.81 next year. At a recent price of $72, would you pay 26 times 1999 earnings for this company?

Before you nod, let's serve up two facts. First, where's the growth? This is a turnaround, right? Yet earnings are expected to climb 9% this year and 12% next year -- and 12% annualized over the next five years. What is the upside of paying more than two times a company's growth rate when, even in today's market, there are plenty of fairly priced securities?

Second, the analysts have a history of being McWrong. Over the last four quarters the company has failed to beat earnings estimates. For two of those periods, the analysts overestimated by a few pennies. Why will things be different this time?

McDonald's has failed. The food fails taste tests. While that might lead one to think that McDonald's has succeeded on marketing, it has failed there too. Ronald McDonald has to be the least appealing icon ever created. Grimace could have been a bloated Barney or a tubeless Teletubby. It never happened. It will never happen. Kids of shareholders don't wear Ronald caps or Hamburglar t-shirts. They do wear a Grimace though, on their faces, when they dig into a McFeast -- and years from now when they realize the dismal returns produced by their investment in McDonald's. Eighty-six number 87 -- you'll be glad you did.

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