Is Don Thompson The Right Man At McDonald's?

Mar. 3.14 | About: McDonald's Corporation (MCD)

When it comes to top brass, McDonald's (NYSE:MCD) has been relatively stable over the past decade. Jim Skinner led the firm from 2004 to 2012, with current CEO Don Thompson in command ever since. However, prior to Skinner's tenure, McDonald's top job was a revolving door. Michael Quinlan was in command until 1998, followed by Jack Greenberg, Jim Cantalupo and Charlie Bell all in a period of only 6 years. Unfortunately both Cantalupo and Bell lost their jobs (and lives) due to illness.

The Thompson Tenure

Enter Don Thompson. His tenure has looked similar to the embattled Greenberg's tenure. Greenberg worked for three years, and his tenure ended with seven consecutive quarters of same-store sales declines. Thompson's entrance has been spotty to say the least.

For the full-year, revenue grew only 2% while global comps were up 0.2%. Admittedly, 2013 was a weak year for global growth, but quick-serve restaurant peers like Chipotle (NYSE:CMG) and Panera (NASDAQ:PNRA) both posted wonderful 2013 results. Even Wendy's (NYSE:WEN) was able to eek out a 1.9% comp for FY13, with 3.1% same-store sales growth in the fourth quarter of 2013.

While McDonald's easily outperformed Wendy's and other peers throughout the midst of the credit crisis, business growth has slowed noticeably as of late. Let's take a look at a few of the issues facing McDonald's and see if Thompson is the right man to lead the company.

Higher Minimum Wage

It seems all but inevitable that the national minimum wage will be higher going forward. Democrats are looking to make the issue a key factor in races going forward, and due to its broad based public support, Republicans are unlikely to oppose an increase, even if it translates to fewer jobs.

McDonald's notoriously depends on minimum wage labor. If the national minimum wage increases from $7.25/hour to $10.10/hour, McDonald's would see one of its key input costs rise nearly 40%.

In order to maintain the same level of profitability, McDonald's will have to make its restaurants more efficient. Thompson served as COO prior to becoming CEO, so it is safe to say he knows the operations of a McDonald's as well as anyone. I think the company will focus on automation as well as labor optimization. Because McDonald's has positioned itself as the value player in the fast-food space, the company will have to avoid raising prices as much as possible. I think Thompson is well suited to tackle this challenge.

Lack of Menu Innovation

Brioche burgers, pretzel pub chicken sandwiches and sea salt fries have been just a few of the innovations of rival Wendy's. Burger King (BKW) has been no slouch either, focusing on several new menu items that include Parmesan chicken sandwiches and a direct competitor to the Big Mac.

Meanwhile, McDonald's Mighty Wings largely failed, and the Egg White McMuffin did not really move the needle. This is where I wonder whether Thompson can succeed. McDonald's could use a new product to help drive business, but I simply do not see a great one in the pipeline. McCafe has not really lived up to its hype in the US.

McDonald's has been testing customizable burger options, but I think the customized approach will negatively impact efficiency - not exactly what McDonald's needs at the moment. Thompson needs to make the right decisions to drive new products to the storefront, and in this respect, he has not proven himself yet.

Expanding Breakfast Hours

Breakfast hours expansion is another area I think Thompson can add some value. Expanding breakfast hours has been an area of controversy over the years. While it seems undeniable that expanding breakfast hours would help boost sales, the cost to franchisees may be prohibitive. Not only would they need to invest in cooking new cooking equipment, but it could also, again, slow service and damage store level operating margins.

Being the operations expert, I think Thompson is well aware of how difficult a rollout will be, which is why I appreciate the firm's cautious approach. At this point, a full-day or at least expanded breakfast hours are on the way. Execution will differentiate whether this is just a move by McDonald's to boost the top-line and appease Wall Street Analysts, or whether the move actually generates a positive ROI for the company and franchisees.

Global Expansion

The United States is undoubtedly a mature market, but McDonald's has the chance to expand its global footprint in the coming years. Thompson is looking toward Southeast Asia and Africa as new growth centers, and I think he will regard the expansion with caution.

Further, with Yum Brands (NYSE:YUM) stumbling in China, McDonald's has a ripe opportunity to pick up market share. McDonald's avoided negative criticism from Chinese news outlets, and its burger-centric menu distances the company from the negative association that may come with chicken.

The Billion Dollar Question

Superseding every other issue in terms of importance, in my view, is a longer-term concern about McDonald's business model. We very well could be in the early stages of an anti-fast-food movement that sweeps the globe. That's not to say people will stop eating out - in fact, people eat outside of the home as much as ever. However, consumers may be ascribing healthy eating a higher value than ever. The sales figures show that millennials would rather eat a meal with "high quality food" at Chipotle and pay a premium rather than grab a burger and fries at McDonald's.

With birth rates largely stagnating and those who are having children waiting until later in life, the family value proposition of fast food may be declining. Consumers who wait until later in life probably have more robust bank accounts and would rather their children be raised on Chipotle and Panera rather than McDonald's and Wendy's. This issue alone is enough to keep me out of McDonald's, and I doubt Thompson can do anything to fight against this potentially crippling headwind.

Staying Away from McDonald's

Ultimately, I am staying away from McDonald's. While I would stop short of calling the company a sell, I certainly see little reason to put new capital to work in the name at this time. At 15x earnings and a 3.4% dividend yield, investors getting McDonald's are probably getting an OK value - though I think earnings are poised to drop within the next few years due to a minimum wage increase in the US.

Is Thompson the right man to lead McDonald's? It is hard to say yes at this point, but he has only been on the job for one year. In my view, it is quite possible Skinner left the company at its near-term peak, leaving Thompson with a very challenging environment. Thompson will be fighting an uphill battle against operating margins, but he can truly prove his value if he is able to maintain or even increase them going forward.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.