McDonald’s Growth Stall is Deadly

McDonald’s Growth Stall is Deadly

by | Aug 9, 2012 | Current Affairs, Defend & Extend, In the Swamp, Leadership, Lock-in

McDonald’s is in a Growth Stall.  Even though the stock is less than 10% off its recent 52 week high (which is about the same high it’s had since the start of 2012,) the odds of McDonald’s equity going down are nearly 10x the odds of it achieving new highs.

A Growth Stall occurs when a company has 2 consecutive quarters of declining sales or earnings, or 2 consecutive quarters of lower sales or earnings than the previous year.  And our research, in conjunction with The Conference Board, proved that when this happens the future becomes fairly easy to predict.

Growth Stalls are Deadly

Growth Stalls are Deadly

 

When companies hit a growth Stall, 93% of the time they are unable to maintain even a 2% growth rate. 55% fall into a consistent revenue decline of more than 2%. 1 in 5 drop into a negative 6%/year revenue slide. 69% of Growth Stalled companies will lose at least half their market capitalization in just a few years. 95% will lose more than 25% of their market value.

Back in February, McDonalds sales in USA stores open at least 13 months fell 1.4%.  By May these same stores reported reported their 7th consecutive month (now more than 2 quarters) of declining revenues. And in July McDonald’s reported the worst sales decline in over a decade – with stores globally selling 2.5% less (USA stores were down 3.2% for the month.)  McDonald’s leadership is now warning that annual sales will be weaker than forecast – and could well be a reported decline.

While McDonald’s has been saying that Asian store revenue growth had offset the USA declines, we now can see that the USA drop is the key signal of a stall.  There was no specific program in Asia to indicate that offshore revenues could create a renewed uptick in USA sales.  Now with offshore sales plummeting we can see that McDonald’s American performance is the lead indicator of a company with serious performance issues.

Growth Stalls are a great forecasting tool because they indicate when a company has become “out of step” with its marketplace.  While management, and in fact many analysts, will claim that this performance deficit is a short term aberration which will be repaired in coming months, historical evidence — and a plethora of case stories – tell us that in fact by the time a Growth Stall shows itself (especially in a company as large as McDonald’s) the situation is far more dire (and systemic) than management would like investors to believe.

Something fundamental has happened in the marketplace, and company leadership is busy trying to defend its historical business in the face of a major change that is pulling customers toward substitute solutions.  Frequently this defend & extend approach exacerbates the problems as retrenchment efforts further hurt revenues.

McDonald’s has reached this inflection point as the result of a long string of leadership decisions which have worked to submarine long-term value.

Back in 2006 McDonald’s sold its fast growing Chipotle chain in order to raise additional funds to close some McDonald’s stores, and undertake an overhaul of the supply chain as well as many remaining stores.  This one-time event was initially good for McDonald’s, but it hurt shareholders by letting go of an enormously successful revenue growth machine.

Since that sale Chipotle has outperformed McDonalds by 3x, and it was clear in 2011 that investors were better off with the faster growing Chipotle than the operationally focused McDonald’s.  Desperate for revenues as its products lagged changing customer tastes, by December, 2012 McDonald’s was urging franchisees to stay open on Christmas Day in order to add just a bit more to the top line.  However, such operational tactics cannot overcome a product line that is fat-and-carb-heavy and off current customer food trends, and by this July was ranked the worst burger in the marketplace.  Meanwhile McDonald’s customer service this June ranked dead last in the industry.  All telltale signs of the problems creating the emergent Growth Stall.

Meanwhile, McDonald’s is facing a significant attack on its business model as trends turn toward higher minimum wages.  By August, 2013 the first signs of the trend were clear – and the impact on McDonald’s long-term fortunes were put in question.  By February, 2014 the trend was accelerating, yet McDonald’s continued ignoring the situation.  And this month the issue has become a front-and-center problem for McDonald’s investors as the National Labor Relations Board (NLRB) has said it will not separate McDonald’s from its franchisees in pay and hours disputes – something which opens McDonald’s deep pockets to litigants looking to build on the living wage trend.

The McDonald’s CEO is somewhat “under seige” due to the poor revenue and earnings reports.  Yet, the company continues to ascribe its Growth Stall to short-term problems such as a meat processing scandal in China.  But this inverts the real situation. Such scandals are not the cause of current poor results.  Rather, they are the outcome of actions taken to meet goals set by leadership pushing too hard, trying to achieve too much, by defending and extending an outdated success formula desperately in need of change to meet new competitive market conditions.

Application of Growth Stall analysis has historically been very valuable.  In May, 2009 I reported on the Growth Stall at Motorola which threatened to dramatically lower company value.  Subsequently Motorola spun off its money losing phone business, sold other assets and businesses, and is now a very small remnant of the business prior to its Growth Stall; which was brought on by an overwhelming market shift to smartphones from 2-way radios and traditional cell phones.

In February, 2008 a Growth Stall at General Electric indicated the company would struggle to reach historical performance for long-term investors.  The stock peaked at $57.80 in 2000, then at $41.40 in July, 2007.  By January, 2009 (post Stall) the company had crashed to only $10, and even recent higher valuations ($28 in 10/2013) are still far from the all-time highs – or even highs in the last decade.

In May, 2008 the Growth Stall at AIG portended big problems for the Dow Jones Industrial (DJIA) giant as financial markets continued to shift radically and quickly.  By the end of 2008 AIG stock cratered and the company was forced to wipe out shareholders completely in a government-backed restructuring.

Perhaps the most compelling case has been Microsoft.  By February, 2010 a Growth Stall was impending (and confirmed by May, 2011) warning of big changes for the tech giant.  Mobile device sales exploded, sending Apple and Google stocks soaring, while Microsoft’s primary, core market for PCs (and software for PCs) has fallen into decline.  Windows 8 subsequently had a tepid market acceptance, and gained no traction in mobile devices, causing Microsoft to write-off its investment in the Surface tablet.  Recent announcements about enormous lay-offs, with vast cuts in the acquired Nokia handheld unit, do not bode well for long-term revenue growth at the decaying (yet cash rich) giant.

As the Dow has surged to record highs, it has lifted all boats.  Including those companies which are showing serious problems.  It is easy to look at the ubiquity of McDonald’s stores and expect the chain to remain forever dominant.  But, the company is facing serious strategic problems with its products, service and business model which leadership has shown no sign of addressing.  The recent Growth Stall serves as a key long-term indicator that McDonald’s is facing serious problems which will most likely seriously jeopardize investors’ (as well as employees’, suppliers’ and supporting communities’) potential returns.

McDonald’s Growth Stall is Deadly

Not All Earnings are Equal – Revenue Growth Matters! (Sell Microsoft)

by | May 3, 2011 | Current Affairs, Defend & Extend, In the Swamp, Leadership, Lock-in, Web/Tech


For the first time in 20 years, Apple’s quarterly profit exceeded Microsoft’s (see BusinessWeek.com “Microsoft’s Net Falls Below Apple As iPad Eats Into Sales.) Thus, on the face of things, the companies should be roughly equally valued.  But they aren’t. This week Microsoft’s market capitalization is about $215B, while Apple’s is about $365B – about 70% higher.  The difference is, of course, growth – and how a lack of it changes management!

According to the Conference Board, growth stalls are deadly.

Growth Stall primary slide
When companies hit a growth stall, 93% of the time they are unable to maintain even a 2% growth rate. 75% fall into a no growth, or declining revenue environment, and 70% of them will lose at least half their market capitalization. That’s because the market has shifted, and the business is no longer selling what customers really want.

At Microsoft, we see a company that has been completely unable to deal with the market shift toward smartphones and tablets:

  • Consumer PC shipments dropped 8% last quarter
  • Netbook sales plunged 40%

Quite simply, when revenues stall earnings become meaningless. Even though Microsoft earnings were up, it wasn’t because they are selling what customers really want to buy. In stalled companies, executives cut costs in sales, marketing, new product development and outsource like crazy in order to prop up earnings.  They can outsource many functions.  And they go to the reservoir of accounting rules to restate depreciation and expenses, delaying expenses while working to accelerate revenue recognition.

Stalled company management will tout earnings growth, even though revenues are flat or declining.  But smart investors know this effort to “manufacture earnings” does not create long-term value.  They want “real” earnings created by selling products customers desire; that create incremental, new demand.  Success doesn’t come from wringing a few coins out of a declining market – but rather from being in markets where people prefer the new solutions.

Mobile phone sales increased 20% (according to IDC), and Apple achieved 14% market share – #3 – in USA (according to MediaPost.com) last quarter. And in this business, Apple is taking the lion’s share of the profits:

Apple share of phone profits 1Q 2011
Image provided by BusinessInsider.com

When companies are growing, investors like that they pump earnings (and cash) back into growth opportunities.  Investors benefit because their value compounds. In a stalled company investors would be better off if the company paid out all their earnings in dividends – so investors could invest in the growth markets.

But, of course, stalled companies like Microsoft and Research in Motion, don’t do that.  Because they spend their cash trying to defend the old business.  Trying to fight off the market shift.  At Microsoft, money is poured into trying to protect the PC business, even as the trend to new solutions is obvious. Microsoft spent 8 times as much on R&D in 2009 as Apple – and all investors received was updates to the old operating system and office automation products.  That generated almost no incremental demand.  While revenue is stalling, costs are rising.

At Gurufocus.com the argument is made “Microsoft Q3 2011: Priced for Failure“.  Author Alex Morris contends that because Microsoft is unlikely to fail this year, it is underpriced.  Actually, all we need to know is that Microsoft is unlikely to grow.  Its cost to defend the old business is too high in the face of market shifts, and the money being spent to defend Microsoft will not go to investors – will not yield a positive rate of return – so investors are smart to get out now!

Additionally, Microsoft’s cost to extend its business into other markets where it enters far too late is wildly unprofitable.  Take for example search and other on-line products: Microsoft online losses 3.2011
Chart source BusinessInsider.com

While much has been made of the ballyhooed relationship between Nokia and Microsoft to help the latter enter the smartphone and tablet businesses, it is really far too late.  Customer solutions are now in the market, and the early leaders – Apple and Google Android – are far, far in front.  The costs to “catch up” – like in on-line – are impossibly huge.  Especially since both Apple and Google are going to keep advancing their solutions and raising the competitive challenge.  What we’ll see are more huge losses, bleeding out the remaining cash from Microsoft as its “core” PC business continues declining.

Many analysts will examine a company’s earnings and make the case for a “value play” after growth slows.  Only, that’s a mythical bet.  When a leader misses a market shift, by investing too long trying to defend its historical business, the late-stage earnings often contain a goodly measure of “adjustments” and other machinations.  To the extent earnings do exist, they are wasted away in defensive efforts to pretend the market shift will not make the company obsolete.  Late investments to catch the market shift cost far too much, and are impossibly late to catch the leading new market players.  The company is well on its way to failure, even if on the surface it looks reasonably healthy.  It’s a sucker’s bet to buy these stocks.

Rarely do we see such a stark example as the shift Apple has created, and the defend & extend management that has completely obsessed Microsoft.  But it has happened several times.  Small printing press manufacturers went bankrupt as customers shifted to xerography, and Xerox waned as customers shifted on to desktop publishing.  Kodak declined as customers moved on to film-less digital photography.  CALMA and DEC disappeared as CAD/CAM customers shifted to PC-based Autocad.  Woolworths was crushed by discount retailers like KMart and WalMart.  B.Dalton and other booksellers disappeared in the market shift to Amazon.com.  And even mighty GM faltered and went bankrupt after decades of defend behavior, as customers shifted to different products from new competitors.

Not all earnings are equal.  A dollar of earnings in a growth company is worth a multiple.  Earnings in a declining company are, well, often worthless.  Those who see this early get out while they can – before the company collapses.

Update 5/10/11 – Regarding announced Skype acquisition by Microsoft

That Microsoft has apparently agreed to buy Skype does not change the above article.  It just proves Microsoft has a lot of cash, and can find places to spend it.  It doesn’t mean Microsoft is changing its business approach.

Skype provides PC-to-PC video conferencing.  In other words, a product that defends and extends the PC product.  Exactly what I predicted Microsoft would do. Spend money on outdated products and efforts to (hopefully) keep people buying PCs.

But smartphones and tablets will soon support video chat from the device; built in.  And these devices are already connected to networks – telecom and wifi – when sold.  The future for Skype does not look rosy.  To the contrary, we can expect Skype to become one of those features we recall, but don’t need, in about 24 to 36 months.  Why boot up a PC to do a video chat you can do right from your hand-held, always-on, device?

The Skype acquisition is a predictable Defend & Extend management move.  It gives the illusion of excitement and growth, when it’s really “so much ado about nothing.”  And now there are $8.5B fewer dollars to pay investors to invest in REAL growth opportunities in growth markets.  The ongoing wasting of cash resources in an effort to defend & extend, when the market trends are in another direction.