Mad Hedge Technology Letter
March 28, 2019
(MACDONALD’S GOES HIGH TECH)
Mad Hedge Technology Letter
March 28, 2019
(MACDONALD’S GOES HIGH TECH)
If McDonald’s is using more technology, then maybe your company should be using more too.
In its most dynamic deal since divesting from Chipotle (CMG) in 2006, McDonald’s acquired artificial intelligence software company Dynamic Yield.
The company is an Israeli startup specializing in software that customizes content to the user.
The result of this ramp up in technology means that your McDonald’s experience is about to improve, become easier and faster.
This is not your father’s McDonald’s.
At handpicked locations in America last year, McDonald’s tested the artificial intelligence software which provides functions such as cross-selling different items on a sidebar and taking into consideration the current weather and time of day.
For example, on hot summer days the machine learning software will most likely recommend colder items such as desserts and soft drinks, and on colder days lean towards a hotter, more filling option.
Another likely consequence is after choosing a full meal of some sort, the software will further prompt the customer of the choice of popular à la carte items via the sidebar.
The theme of digital transformation is upon us and following the lead of other fast food companies such as Domino’s Pizza (DPZ) will make operations more efficient and appeal to different segments of society.
The decision to gentrify and digitize the customer experience could be a result from a stagnating fast food industry that is in a price war down to the bottom.
Did you know you that you can buy 10 chicken nuggets for $1 at Burger King now?
Or even a simple cocktail at Applebee’s for just $1?
QSRs (quick service restaurants) have lagged posher establishments caused by the cutting down of immigration and the struggling of the low-income class that is squeezing out fast food restaurants’ go-to clientele base.
And as construction rates have crashed because of the surging material costs induced by tariffs and a lack of foreign workers, McDonald’s has been forced to look to replace demand.
Construction workers are a healthy portion of McDonald’s domestic lunch demand.
Not only is foot traffic being affected, but the fast food industry in America is saturated and funnily enough, when I travel to Europe every summer, this is one of the first comments I get from the Europeans.
The drive-thru menu will be one of the primary beneficiaries of this new software, and the projected enhancement of customer satisfaction should drive higher retention rates.
McDonald’s plans to roll out kiosks that self-serve customers which is one stop on the way to a fully automated experience.
In the next 5 or 10 years, there might be only one or two McDonald’s employees running a franchise.
McDonald’s is clearly trending towards reducing employee headcount evident in their strategy of deciding to halt lobbying efforts to bring down the minimum wage.
Genna Gent, McDonald’s Vice President of U.S. government relations, went on record sharing that “outlets owned by the company have an average starting wage that exceeds $10 per hour.”
Most fast-food companies would be frightened to discover the House Committee on Education and Labor advanced a bill earlier this month to increase the minimum wage from $7.25 to $15 per hour by 2024 thus incentivizing McDonald’s to pick up the pace of their digital transformation.
McDonald’s is not only one of the biggest employers in America, but they are one of the largest in the world.
The company had 210,000 employees in 2018 and I believe they will be able to quickly get down to 150,000 with the new software streamlining employees’ tasks allowing franchises to reduce headcount.
Getting on top of the mobile app and optimizing delivery is another step to McDonald’s digital growth strategy.
The adoption of machine learning will at some point allow customers to reorder their favorite meals on demand or before they enter the establishment, and even possibly personalizing parts of a meal that can mix and match to create alternative meals.
And the beauty of all of this, the same software rolled out to the self-serving kiosks, drive-thru platform, and mobile app can be universally adopted and managed from the cloud causing massive savings from tech efficiencies.
McDonald’s is not without its share of difficulties, sales have been plunging since 2014 and part of the response to this was to start the digital transformation.
This is just the second step of a long drawn own process that will automate the production process and customer experience.
On the flip side, the 3-year EPS growth rate is 16% demonstrating that even with falling sales, the efficiencies are falling down to the bottom line with the company profiting over $5 billion in 2018.
Ironically enough, McDonald’s profits were substantially lower with higher sales, indicating to management that a leaner version of itself has been justified.
I believe McDonald’s will continue to gentrify its menu, digitize its customer experience and production process, and sale deceleration will slow down while profit acceleration and EPS will increase.
This is a good omen for the stock’s trajectory and the company continues to be a good buy on the dip candidate because its upward share movement is entirely correlated to the increasing profitability which it continues to deliver on.
As we inch closer to a recession, deterioration of economic conditions could push an unintended growing number of customers through McDonald’s arched doors as they usually attract customers who earn less than $45,000 per year, looking to save some extra cash.
This could set the stage for a reawakening of increased sales.
Global Market Comments
October 3, 2018
(TAKING A LOOK AT GENERAL ELECTRIC LEAPS), (GE),
(TEN SURPRISES THAT WOULD DESTROY THIS MARKET),
(USO), (AMZN), (MCD), (WMT), (TGT)
Anyone wondering about the long term future of the US economy is amazed at how fast it is evolving.
There has been an unrelenting growth of services’ share of American GDP, from 25% to 45% over the last sixty years.
Far and away the fastest growth area for the past eight years has been health care, thanks to Obamacare. With that program now headed for the dustbin of history, those job gains are about to be quickly unwound.
It takes one health care professional to take care of 14 Americans. If you eliminate health care for 20 million, that eliminates 1.42 million jobs.
That’s what will happen if our national health care is eliminated without a replacement.
This is not necessarily a bad thing. Would you rather be mining coal or designing a website? Do you want to earn $12 an hour, or $150?
These statistics make us the envy of the world, as services are where the future lies. By creating so many key technologies, our country has been the most successful in the world in climbing up the value chain.
China can have all the $3 an hour jobs it wants.
Services largely comprise pure intellectual content, require no raw materials, and the end product can be transmitted over the Internet.
There is a reason why nearly a million foreign students have flocked to the US for an education.
Emerging nations like China and South Korea, which only see services generating 10%-15% of their GDP, are wracking their brains trying to figure out how to play catch up.
McDonald?s (MCD) has always figured large in my life.
I grew up next door to one of the first five stands built in the country, in the Los Angeles metropolitan area. That?s when visionary milkshake mixer salesman, Ray Kroc, started to franchise his revolutionary new ideas for delivering fast food.
One of my fondest childhood memories was when my mother used to take us out to dinner there. At 15 cents a burger you fed seven growing kids for a buck and still had money left over for French fries. We brought our own cokes in an ice chest to save money.
I always gummed up the works by asking for a hamburger that had mustard only and no pickles. I clearly did not fit into the company?s stripped down Speedee Service business model.
In high school, I managed to land a coveted minimum wage job ($1 an hour) under the Golden Arches. I learned first hand the harsh realities of working for a living, and that you didn?t necessarily want to know how the sausage was made.
Then, the Big Mac came out, the blockbuster beef equivalent of a Saturn V rocket. Chicken McNuggets, Egg McMuffins, and Filet of Fish followed (for the Catholics on Fridays), and it seemed the company could do no wrong.
In a few decades, the company grew into the world?s largest restaurant, expanding its list of franchises to a staggering 36,000 shops in 119 countries.
It became the planet?s largest consumer of beef and potatoes in the world. Its presence is ubiquitous on US military bases around the world. Its chocolate shake is said to be able to withstand a nuclear attack.
However, since 2011, the stock has largely failed to perform, and has greatly underperformed the S&P 500. Its business model is aging. Its menu needs a major reworking.
The company has suffered sales declines at existing locations in five out of the last six quarters, with the rate of decline accelerating this year.
The problem is that people just don?t want to buy what they make anymore.
I went into a store the other day, and I was appalled. It was almost empty.
The few customers it had all seemed sick, obese, or unemployed, wearing polyester clothes. They periodically ducked outside for a quick cigarette.
They needed a double bacon cheeseburger like a hole in the head. Health was not their priority. They were a market that was literally dying.
It is becoming increasingly clear that the American market is moving beyond McDonald?s. Can the long vaunted company now play catch up?
This is the big problem. Millennials, those aged 18-34, which should be the company?s highest growth market, aren?t showing much interest in the company?s secret sauce.
They are, in fact, adopting a complete different life style that doesn?t have Ronald McDonald anywhere in it. They are very cautious in what they put in their young bodies.
Think organic, locally grown, low fat, low calorie, non-GMO, high fiber, and no artificial hormones or coloring anywhere. Think of health food, and you don?t exactly run off to a McDonald?s to eat. McDonald?s has a serious brand problem.
Organic foods are booming, seeing sales growth of 30% a year nationally, with far higher profit margins.
If you don?t believe me, look no further than the stock chart of Whole Foods (WFM) below, which at one point, saw its shares gain 116% relative to (MCD).
This is also a generation that is vastly more environmentally conscious that the Gen Xer?s and baby boomers before them. Beef is the single most environmentally destructive food product you can buy, with all the waste and methane byproducts.
One quarter pound beef patty requires a profligate 450 gallons of water to produce. That?s double the daily ration for a family of four here in drought suffering California. And who knows what the hell they are putting in it to preserve it down a very long global supply chain.
McDonald?s did make some limited progress on this front by announcing that they would no longer put ?pink slime? into their beef patties. If you don?t know what ?pink slime? is, then you don?t want to know. Suffice it to say that it is definitely not a great new marketing angle for health food nuts.
The company is also encountering ferocious competition for the fast food dollar from the new, rapidly growing ?fast casual? industry. These include Five Guys, Shake Shack (SHAK), Chipotle Mexican Grill (CMG), and Panera Bread (PNRA).
These companies are all snapping up the high margin end of the market, even though any one of them is miniscule in size when compared to McDonald?s. Collectively, they are nipping at Ronald McDonald?s heels.
I can?t even get my own kids to eat at McDonald?s anymore, they preferring the legendary In and Out Burger on the West Coast (no double entendre intended), which emulates the McDonald?s stripped down menu of the early 1950?s.
(In and Out is a fascinating business story for another day, as the $2 billion, 300 stand LA based company is now controlled by a 33 year old four time married heiress named Lynsi Snyder.)
McDonald?s is one of the world?s largest and best managed companies. In 2014 it generated an impressive $4.8 billion profit on $27.4 billion in sales, producing a not too shabby net margin of 17.5%. So we?re not, by any means, talking chapter 11 material here.
But it is going ex growth, and that invites a lower stock multiple, and a lower stock price, something you, as equity investors should be aware of. Is (MCD)?s position in the Dow Average 30 at risk?
Yikes! That would be a disaster for shareholders!
The company has seen the writing on the wall. It recently brought in a new CEO, Steve Easterbrook, to shake things up. But so far, all of the changes he has implemented have been administrative in nature. There is no category killing super burger anywhere on the horizon.
McDonald?s does still have some huge advantages. Its efficiencies, purchasing power, and economies of scale are epic. But the business is so enormous that any incremental change is unlikely to move the needle on the earnings front.
It is the classic dilemma when navigating a supertanker.
Another headache arises from the snowballing minimum wage, or living wage movement, which has McDonald?s squarely in its crosshairs. This promises to be a big political campaign issue in 2016.
Several cities, like San Francisco and Seattle, have already boosted pay from $8 to $15 and hour, which would substantially increase (MCD)?s operating costs and cut its price advantage.
It is possible that McDonald?s could go the route of so many other legacy industries that were born here, and then migrated abroad when the home market disappeared. I?m thinking about cigarettes (Altria Group (MO), Kentucky Friend Chicken (YUM), and coal (PEA).
Indeed, on my last trip to China, I ate regularly at McDonald?s, and couldn?t help but notice that it had become the country?s hot high end date. But the burden of proof lies on the current management as to whether they can pull this off.
So, you won?t find me buying (MCD) shares anytime soon. If you must own it for that generous 3.6% dividend, at the very least you should be writing covered calls against your position to take in premium income to offset the lack of capital appreciation.
In the meantime, I?ll be grabbing a double cheeseburger and chocolate shake at In and Out Burger, even though the lines there can be miserable.
My former employer, The Economist, once the ever tolerant editor of my flabby, disjointed, and juvenile prose (Thanks Peter and Marjorie), has released its ?Big Mac? index of international currency valuations.
Although initially launched as a joke three decades ago, I have followed it religiously and found it an amazingly accurate predictor of future economic success. The index counts the cost of McDonald?s (MCD) premium sandwich around the world, ranging from $7.20 in Norway to $1.78 in Argentina, and comes up with a measure of currency under and over valuation.
What are its conclusions today? The Swiss franc (FXF), the Brazilian real, and the Euro (FXE) are overvalued, while the Hong Kong dollar, the Chinese Yuan (CYB), and the Thai Baht are cheap. I couldn?t agree more with many of these conclusions. It?s as if the august weekly publication was tapping The Diary of the Mad Hedge Fund Trader for ideas. I am no longer the frequent consumer of Big Macs that I once was, as my metabolism has slowed to such an extent that in eating one, you might as well tape it to my ass. Better to use it as an economic forecasting tool, than a speedy lunch.