McDonald's Corporation's Management Presents at Goldman Sachs Global Retailing Conference (Transcript)

Sep.11.13 | About: McDonald's Corporation (MCD)

McDonald's Corporation (NYSE:MCD)

Goldman Sachs Global Retailing Conference

September 11, 2013 08:50 a.m. ET

Executives

Tim Fenton - Chief Operating Officer

Peter J. Bensen - Executive Vice President and Chief Financial Officer

Analysts

Michael Kelter - Goldman Sachs

Michael Kelter - Goldman Sachs

Good morning. I am Michael Kelter the restaurant's analyst at Goldman. I want to introduce, as if they need introduction, McDonald's, the world's largest restaurant chain with system wide sales of $90 billion, over 30,000 locations in 119 countries, growing over 1,000 units each year; market cap approaching $100 billion.

With us today we have Pete Bensen, CFO and Tim Fenton, COO. Pete has been with McDonald's for the past 17 years and he's been CFO for the past five. Tim has been with McDonald's for 39 years, most recently as President of McDonald's Asia, before becoming COO.

With that I hand it over to Pete and Tim for their presentation.

Tim Fenton

Thank you and good morning everybody. It's a pleasure to be here with you today. It's my great privilege to serve as Chief Operating Officer for McDonald's, a role I have had now for 15 months. Over my 40 year career with McDonald’s I have lived and worked in a number of countries, from Asia to Europe to the Middle East and back to the U.S.

So I am really excited to bring my global experience to help continue building our brand around the world. Today I would like to spend a few minutes talking about our global business, McDonald’s solid business foundation to stay in the current environment. And what we’re doing to remain focused on our long-term as we navigate through these short-term challenges.

Then Pete our CFO will continue, come up and provide a little bit more financial performance for McDonald’s.

McDonald’s continues to be a destination for more than 69 million customers everyday around the world. We are really proud of what we deliver globally; great tasting food, high quality food in contemporary restaurants at affordable prices.

While we have a strong presence in the trillion dollar global informal eating out category nearly 35,000 restaurants account for less than just 10% of the total eating out, informal eating out sales. So our opportunity for growth clearly remains.

That said we are working through this tepid environment, includes several broad-based challenges. Economies around the world reflect ongoing weakness and mixed signs of slow recovery with global unemployment at its highest level in three years and GDP growth at its lowest levels since 2009. Overall economic uncertainty continues to dampen consumer spending. And so growth in the informal eating out industry is expected to remain sluggish.

However I am confident in McDonald’s ability to navigate through these near term challenges while still driving long-term growth. We have a strong proven strategy in our plan to win, a framework that guides our efforts. We have robust consumer focused plans that are driven by our global growth priorities of optimizing our menu, modernizing the customer experience and broadening accessibility to our brand.

And most clearly in these times we are thoughtfully refining and enhancing our tactics we need in order to stay relevant and compelling to our customers, refining our plans and staying flexible. It helped us maintain or grow market share in most of our major markets around the world. And yet we know we need to work even harder and smarter to drive the top line and the bottom line.

So we are putting even greater emphasis on gaining a better understanding how we deliver on evolving customer needs to more robust insights analytics, better leveraging our global systems to share and scale our best ideas more quickly across different markets and strengthening our dayparts by breakfast and lunch while expanding our dinner and late night occasions where our customers want us to be.

With that let me highlight how we are bringing all of this focus to life as we work to continue to drive our growth opportunities, starting with optimizing our menu, with relevant food and beverage offerings. We continue to balance the strength of our global core menu with efforts to remain locally relevant across all product categories, dayparts and price points.

Our core iconic products remain front and center for us and we continue to promote them as well as look for ways to extend and modernize them for our customers. Earlier this year we re-launched the quarter pounder in Japan and in the U.S. This summer we reenergized the quarter pounder brand with a line of three new flavors. We’re also strengthening our established platforms of relevant new offerings particularly our top growth categories of beef, chicken, beverages and breakfast.

Recent examples include the introduction of the new Egg White Delight McMuffin, premium Chicken McWraps in the U.S, the launch of smoothies and frappes this summer in the UK and also expanding our premium products within a variety of specialty chicken and beef sandwiches across Europe to deliver a higher average check.

Around the world we continue to strategically spend on menu across all dayparts. This includes new late night and overnight menus in the U.S. and Asia as well as a strong push on breakfast. Well folks [aren't] going to breakfast in markets from China, to Japan to the UK and Germany where breakfast as a percentage of total sales historically has been well below the U.S. breakfast business which represents about 25% of total sales.

And lastly on the menu, we’re putting even greater focus on innovating locally, sharing winning concepts and quickly scaling them across our system. Today, McDonald’s contemporary look is reflected in more than 60% of our interiors and 50% of our exteriors globally. United Kingdom is a great example of the power of critical mass. With reimaging in UK essentially complete, this market continues to deliver strong year-over-year sales increases.

In the U.S., we continue to see average sales lift from our reimage restaurants approaching 67%, above the local market after one year. In 2013, we plan to reimage over 1,600 restaurants globally. As more markets become substantially modernized our pace of reimages will obviously slowdown. That’s why it’s important to note that the modernization goes beyond reimaging. It also includes the many other ways our customers interact with our brand.

There is delivery in APMEA, there is self-ordering kiosks in Europe and a growing presence across the broad spectrum of initiatives in the digital area. We are determined to keep strengthening our digital engagement. So we’re evaluating initiatives for mobile ordering, mobile payment and other smartphone tie-ins, all just to stay in step with how our consumers live today.

Our third growth priority is broadening accessibility by continuing to make McDonald’s available to more customers more often. This priority is about several things. First, it’s about making sure we continue to meet our customers’ needs by offering compelling value at every price tier. We’re creating this balance through great products at affordable prices, complemented by premium products and promotions that encourage trade-up and higher average check. We’re continuously listening to our customers. And we innovate in response to those insights and changing consumer needs.

In Germany for example, we’ve continued to refine our value offers across the dayparts to further strengthen our value perceptions for a very price sensitive consumer base. In France, our new Casse-Croute sandwich and drink combination has been positively received in the broad market as it offers -- as an offer below the critical fiver-year old price point. The price level had been under-represented on our menu in the past.

Let's take a look at how France is highlighting this offering.

[Audio-Video Presentation]

Broadening accessibility is also about extending our operating hours in more restaurants and doing more to maximize restaurant throughput and capacity. In U.S. for example in June, we introduced McDonald’s after midnight. This menu combines the most popular selection of breakfast and regular menu items. So it’s focused on what our customers want during the overnight.

Here is a quick and fun spot that we ran to help introduce this menu.

[Audio-Video Presentation]

Currently nearly 50% of the U.S. restaurants operate 24x7 with a goal of having 60% by the year's end and more opportunity for McDonald's after midnight across the market. In addition one-third of our restaurants now use some form of multiple order points in the drive through to help drive greater capacity and throughput. This includes tandem side-by-side and hand held order taking.

About 80% of our restaurants can still expand capacity by executing current labor and operational enhancements with no capital investment involved. And finally we continue to strategically add new restaurants. People talk about our development pace in a moment. But before I turn it over to Pete I want to reemphasize my confidence in our future. Looking back as my first year as Chief Operating Officer I have several key takeaways I’d like to share with you.

Our three global growth opportunity and priorities are relevant, actionable and present significant opportunities to stretch and grow. We have a clear and straightforward vision for continued growth. We have the right strategies in place and are making the appropriate adjustments to be successful today and tomorrow.

And we continue enhance our operating platforms, our restaurants, our global food pipeline and our overall customer experience. Thank you and with that I will introduce Pete. Pete?

Peter J. Bensen

Thanks Tim and good morning everyone. It’s a pleasure to be here with you. I want to echo Tim's sentiments about McDonald’s strong business foundation and our ability to navigate the challenges of today while driving long term growth into the future. We continue to operate from a position to strength based on our key differentiating attributes.

A unique franchise business model, that encourages the entrepreneurial spirit of local businessmen and women who operate approximately 28,000 of our nearly 35,000 restaurants around the world; the powerful alignment of our system around the strategies and key priorities that have allowed us to maintain or grow our industry leading market share in most of our major market; and a strong financial foundation that allows us to invest for the future while making prudent decisions that deliver near term performance.

These attributes provide us with significant competitive advantages. We continue to develop and leverage these strengths as we manage the business through the current environment while building for the long term.

Looking specifically at 2013 our results through June have been mixed. In constant currency sales have increased 3% driven by restaurant expansion while total revenues rose 2% and earnings per share increased 5%. Combined operating margin declined 30 basis points to 30.3% compared to the prior six month period.

While our margin remains solid with our industry we are not satisfied with this result. Combined operating margin is a critical measure because it speaks to our fundamental economic model which is to grow profitably by effectively driving top line sales and margin increases while managing expenses.

I use this method to analyze our 2013 operating performance. There are several key drivers of combined operating margins but the most significant is franchise margin dollars which represents more than two-thirds of our total restaurant margins. The magnitude of the franchise margin dollars is based on a large percentage of restaurants around the world that are franchised.

Franchises operate over 80% of our nearly 35,000 restaurants around the world. Given the significance of the franchise margin dollars relative to overall operating income the combined operating margin is highly sensitive to changes in the underlying factors impacting franchise margins.

The most significant driver of franchise margin growth is comparable sales performance. This is because more than 80% of franchise revenue flows directly through to the franchise margin due primarily to the relatively low direct cost in our model. In addition a large percentage of these direct costs are relatively fixed.

Through June 2013 global comparable sales were flat as a result the franchise margin percent declined 50 basis points to 82.3% with each of our major areas of the world declining. For the remainder of 2013 the forecast calls for continued pressure on IEO industry growth. Increasing comparable sales in this environment requires discipline with regards to pricing especially considering that value plays such a vital role.

So unless there is a dramatic change in the economy or in people’s eating behaviors the size of the industry will remain relatively stagnant, pressuring our franchise margin and therefore our combined operating margin growth. The good news as you heard from Tim is that through some of these adjustments we’ve made we are maintaining a growing market share in most of our major markets despite the challenging macro environment.

The next key factor impacting our combined operating margin is company operated margins which represents the remaining one-third of our restaurant margin dollars. Like franchise margin, company operated margins are impacted by comparable sales performance. However restaurant expenses also play a key role. Each of our restaurants effectively represents an individual small business.

It’s no secret that running a small business in today’s environment is tougher than it was just few years ago given rising employee and commodity costs, more competition, heightened regulations and rapidly changing technology. With limited comparable sales growth overcoming these challenges is even more difficult.

As a result our company operated margin percent declined 90 basis points to 17% through June 2013 also impacted by all areas of the world. While we continue to make adjustments and prudently manage our restaurant expenses we are still faced with an ongoing challenging environment and as long as IEO industry growth is constrained and costs increase we expect our company operated margins to be pressured.

The final component of combined operating margin analysis is G&A. G&A discipline remains an area of focus, as we seek to grow sales and revenue faster than our G&A spends. As we seize the potential for more growth in the future our intent is to manage this expense effectively, investing where appropriate while seeking efficiencies where warranted.

Over the past five years we have consistently reduced G&A as a percentage of revenues. Through June 2013 total G&A spending was 1% lower than the prior year or 8.8% of revenues, due impart to lower incentive compensation as a result of softer performance and other efficiencies that we have identified.

With a combined operating margin at approximately 30% we see opportunity for continued growth over the long-term. Strong comparable sales and margin expansion will be the key drivers of McDonald’s combined operating margin growth.

In addition as you can see in this slide a mature, more heavily franchised system such as the U.S. at 89% franchise can yield a combined operating margin in excess of 40%. Opportunities to increase our franchise presence most notably in places like Russia and China will contribute toward increasing our combined operating margins in both Europe and APMEA.

Our heavily franchised business model continues to generate a healthy level of cash. For perspective McDonald’s cash from operations has exceeded $5 billion per year since 2008. And last year our cash from operations reached almost $7 billion. Our first priority for this cash remains reinvesting in our business to drive future growth in returns.

For 2013 our capital expenditures are expected to be about $3.1 billion. Over half of this amount will be used to open more than 1,500 restaurants in established markets like the U.S., France, Germany, Canada and Australia and emerging markets like China and Russia. The remainder of our CapEx will be devoted to investing in our existing locations, including reimaging over 1,600 restaurants globally.

After reinvesting in the McDonald’s business we expect to return all free cash flow to investors through a combination of dividend and share repurchases over time. Historically our predictable cash flow and strong balance sheet have enabled us to return substantial amount of cash to shareholders. For the five year ended 2012 we returned more than $27 billion to shareholders including a return of $5.5 billion in 2012.

Through June of this year we’ve returned a total of $2.3 billion to shareholders including $1.5 billion of dividends paid and another 800 million of shares repurchased. A combination of factors impacted consumers worldwide and our business as well but we can’t attribute all of our challenges to the external environment.

As the world shifts we have and must continue to adapt to address the changing needs of our customers. Notwithstanding the pressures we are experiencing today we remain confident in our future. We don’t manage our business one day at a time, we manage it for the long term and we are committed to excellence in every environment we operate in.

Our confidence in the power of the McDonald’s system has never been stronger. We have defensible competitive advantages, a resilient business model and the necessary alignment around the world around our three global growth priorities with our owner-operators, our suppliers and our company teams to drive enduring profitable growth for our system and our shareholders for the long term.

Remaining focused on the consumer enables us to develop solutions that are unique to McDonald’s and more importantly make a difference to the more than 69 million guests around the world that we serve each and every day. Thanks with that Tim and I will do some questions.

Question-and-Answer Session

Michael Kelter - Goldman Sachs

Thank you. I think a good place to start where in the U.S. you talked about the macro and the industry restaurant industry in particular being a little bit sluggish. How is that impacting the competitive environment not necessarily just the consumer but our competitors beginning to get less rational in some regard.

Tim Fenton

All you need to do is walk outside and look at what's in the restaurants windows so it’s a street play, there is a lot of price, lot of discounts, lot of couponing going on, even more so then we’ve ever seen it all dayparts. So with the IEO declining or staying flat at best, fewer customers and everyone’s going after the same customer for market share and it’s a tough fight right now.

Michael Kelter - Goldman Sachs

And then may be as a follow up, you guys have been reluctant to take the price increases given that environment and it makes total sense. On the other hand this is hurting same-store sales and margins something you talked about a little bit when you presented. Could you may be take more pricing than you’ve been giving yourselves credit for, could the brand withstand that?

Peter J. Bensen

You know it’s a constant balance, Michael that we kind of work thorough with. In this environment that Tim described where the industry isn’t growing that means we are fighting for the same customers that everyone else is. And value plays such a key role in attracting those customers.

So in that environment the U.S. team is going to be a little more prudent about the level of price increase but yet look for other mechanisms to may be build average check. So things like short term promotions, that might come in with an average check a little bit higher than average can drive a little bit more margin potential for example. So it will be a combination of monitoring the environment and using potentially short term promotions to help boost average check in the near term.

Michael Kelter - Goldman Sachs

And the barbell strategy I guess I -- means that you have the value message which has been working at the lower end and then at the higher end you have new product introductions, the most current initiative Mighty Wings some people are excited about.

And I was curious to hear from you, how it performed in test markets in Atlanta and Chicago, what you learned and what was available in those markets? And maybe as part of the answer, why you’re launching it as a limited time offer as opposed to a permanent menu addition?

Tim Fenton

Well, it performed quite well in Atlanta and Chicago. And it took us almost a year to develop the supply chain and inventory to take it nationally. Our partners in the north in Canada would love to have been on this program with us and leverage the media spend that we’re going to have, just didn’t have the supply chain.

So it’s a six to eight week promotion, we will -- if it’s as successful as we anticipate it will be, then we’ll work very diligently on getting more chickens. But this is something that you do have to start at times well in advance.

Michael Kelter - Goldman Sachs

And what are the things, maybe qualitative that you learned in those test markets, beyond just that it did well and consumer were receptive to the idea, what are some of the nuances you picked up?

Tim Fenton

The three piece was an add-on, so we would have a meal and would buy a three piece to as a takeaway with a higher average check, really resonated well in Hispanic consumer base and African-American consumer base. I think the things different about this time is our tie-in that we have with the NFL. We’ve got a very, very clever tie-in with three of the NFL’s star athletes, little bit of a game, I can’t talk about it. It’s kind of a mystery that will be out there starting on the 17th.

Michael Kelter - Goldman Sachs

And maybe another angle at this is on the one hand Mighty Wings is the first unique product platform in a while and should help drive traffic if successful. And on the other hand, it does add complexity. And some people are concerned that with the continual product introductions that it’s become more difficult for the franchisees to operate. Do you feel like the wing platform is going to be more difficult, slow down, throughput in any way or is it not an issue at in Mighty Wings or any product is not an issue in the current system?

Peter J. Bensen

We’ve been working on this for a year. We’ve gone through all our staffing positioning, hiring guys, training guys. The one thing that -- you're right, the one thing is there is a longer cook time on the wings, but we’ve got ample cabinets and storage. We’ve gone through all the training with our folks and positioning. I think we’ll be fine on that part.

Michael Kelter - Goldman Sachs

And then what about beyond wings? I know you don’t want to talk about your NPD pipeline too much for competitive reasons but what can you tell us to get us excited about what’s coming next, what types of things should we expect from you, anything in the pipeline that you’re particularly excited about?

Tim Fenton

Well, we’ve got a lot going in beverage with our McCafé line, we’ve got some products coming out this fall, we’ve got some new products that we’re bringing out next year. One of the things that we’re finding is the consumer, particularly millennials lot more customization. So, we’re looking at different ethnic flavors that we can add to our products, different sauces, different ingredients that we’ll be able to put on our burgers. We’ve invested in our top line to have the capacity to do such, but you will see some of that coming out next year.

Michael Kelter - Goldman Sachs

And then maybe we’ll switch over to Europe. That’s an important part of your business, macro has been tough, but you’ve put, posted your same store sale yesterday and Europe was a very positive surprise to the upside, it's something that you might classify as green shoots or was there something specific to the month of August that we shouldn’t get excited about?

Peter J. Bensen

Michael, one month doesn’t make a trend, but obviously we’re encouraged by the results. And the biggest difference in Europe’s performance in August relative to the prior months in the year actually was the performance in France. So France had a particularly strong month, part of that was benefited by the Ramadan shift because of their Moslem population.

But they did a very successful core product promotion that featured the core product that Tim showed in his slide, which is encouraging from the standpoint that it wasn’t a discount, it wasn’t a huge deep value play, but it was our core products at regular menu prices that resonated.

And so obviously we’re encouraged by the results. But again, it’s something we’ll continue to watch. I think more broadly Europe are there signs of green shoots I guess I'd say things are less negative that they had been but you still have very high levels of unemployment, very low consumer confidence by historical standards; these governments that have these high levels of debt and these austerity measures. All of those factors combined don’t make for a really great consumer environment.

So well yes August was encouraging for us, it's going to continue to be a street fight there we’re going to continue to win the battle over the long-term but it’s going to take a while before that area really rebounds, I think.

Michael Kelter - Goldman Sachs

How about an update on China, I know you have people right now on the other side of the world giving an update on China from your perspective. Maybe just kind of balance the long-term potential which is I think obvious versus the near term challenges in that country whether macro avian flu headlines things of that nature how are you managing the business differently how are you doing?

Tim Fenton

Well China is a dynamic market for us. What we’re going through right now is I think this is the lowest GDP growth that the country's had in 20 years. And most countries would love to have 7% GDP growth, it's little tough in China. But we’ve always had a long-term approach in China. We went through a similar situation back in 2008.

So we’re grounded on all of our value strategies there everything is intact our operations are intact there. We’ve built a phenomenal team on development so we’ll continue to open new restaurants at a pace of we’ll open about 275 this year which will be another record.

You may have read that we did cull back about 50 locations that probably a little bit too premature where we were going. But China is and will continue to be a long-term growth for us if I look back last five years we’ve doubled our total sales. We’ve doubled our total income in last five years.

So it remains less than 4% of our overall operating income but we continue to invest and grow as we know that the long-term channel would be very well for us. There is a couple of bumps in the road and you’ve read about what is the environment there. We are faring probably much better than some of our counterparts there right now.

Michael Kelter - Goldman Sachs

And the 50 units that you cut back on what was the common theme amongst those 50 why did they get cut?

Tim Fenton

Some of them were, we call greenfields something that would take a great area but might take three to five years for it to develop so we were little premature so we cut back in some of the premature ones or ones that really didn’t meet out schemes over a three-year period.

Peter J. Bensen

And only about a third of those were kind of completely cut out of our pipeline and other two-thirds were just delayed, general hygiene I would call it nothing dramatic.

Michael Kelter - Goldman Sachs

And at the enterprise level including China looking well beyond and throughout the rest of the world the plan is for 1,200 net new units this year. That’s the most you would have opened in 10-15 years. What’s going on behind the scenes that you guys feel this is the right time to accelerate unit openings at McDonald’s?

Tim Fenton

A couple of things Michael actually the performance over the last several years we’ve significantly increased average unit volumes in virtually all of our markets around the world. We’ve got better tools and technology than we had even five years ago to identify the trade areas where there are gaps that we could fill in. The tools we have to estimate the sales impact from your home shopping and work gives us a higher degree of confidence as we look to open new sites.

And really 10 years ago when we dramatically cut back on openings we’ve kind of decimated some of our development teams around the world, so we kind of lost some of the talent and experience that we had in those areas. And as we’re focused on comp sales at the same time kind of rebuilding that muscle if you will, we think we have the right talent, the right tools and tremendous opportunity in certain markets. This isn’t like we’re expanding in all 119 markets at the same rate.

We’re being very strategic about where those growth opportunities and the resources that we’re allocating to them.

Michael Kelter - Goldman Sachs

Now the margin pressures that you talked about, could you I mean some of as you explained isn’t going to necessarily recover until the environment gets better. But at the same time you’ve also referenced in the past some of the things McDonald’s is doing to take fate into your own hands, could you kind of elaborate on those things, both at the store level and maybe in G&A, what are the things you’re doing to recover margin, even in this environment?

Peter J. Bensen

Well, it’s a multi-pronged approach. So, on the top line, as I alluded to a little bit earlier, if -- we’ll look to take as much price as we think we can in this environment. But if raising prices isn’t the answer per se, what can we do from promotional activity to help drive check, so things like the Mighty Wings, other promotional activities, Europe does a great job with pulsing in premium food events that can add to the average check without necessarily across the board menu price increases.

From the efficiency side, our supply chain, we have the best supply chain in the industry, I would argue. And they do a great job of managing and controlling our input cost from the commodity side.

On the labor front and Tim does a lot of work in this regard, really focusing on our labor efficiency. So we have labor efficiencies in our restaurants, a primary one is transactions for crew hour that we look at and manage, and share best practices around the system that weighs to be even more efficient at filling orders in this environment that we can be as efficient as we can be with labor. And just generally, in an environment like this, questioning all expenditures to make sure they’re needed and necessary in the environment.

Michael Kelter - Goldman Sachs

And I think we have time for one last question before I move to the breakout, and it’s one that I’ve actually gotten asked quite a bit of late, a sign of the times, your capital structure. And whether or not there is opportunity for you guys to take on some more debt, given the low interest rate environment, be very accretive to your equity holders. Can you talk about the puts and takes there? And I know your credit rating is sacrosanct, but is this the moment of an exception because we’re in an exceptional time of low interest rates?

Peter J. Bensen

You’ve gotten a lot of questions on that as have I. Our credit rating, our single A credit rating is very important to us. One, obviously it gives us great access and great pricing to the debt markets. It also has a halo effect to the McDonald’s system. So while we’re not involved in our franchisees or our suppliers' credit facilities, the strength of that our credit rating in the system does benefit them and anecdotally, we hear they do borrow it at very attractive rates.

We ask our franchisees to be financially strong and to invest in the business. So for us to weaken our financial condition and not plough those proceeds back into the business, we believe would cause more long-term value destruction in that misalignment with the franchisees than it would short term benefit for the shareholders. And really over time, we have added that. So the last couple of years we’ve added over $2 billion of debt to supplement the free cash flow for shareholder returns and we’ll add debt again in 2013, albeit a smaller amount that we’ve added the last couple of years. It continues to be a part of our strategy to enhance the free cash flow, yet the governor is that single A credit rating for us.

Michael Kelter - Goldman Sachs

I want to thank you very much for being here. For those of you who are interested in following up we’re going to be moving up to the fourth floor to the Rendezvous room for Q&A. Thank you. We appreciate it.

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