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Remodeling, Discounting Vex McDonald’s Franchisees

The latest survey of McDonald’s franchisees conducted by Janney Capital Markets analyst Mark Kalinowski offers some insight into how remodeling investments and marketing programs such as discounting are viewed by some operators. Their unease about the cash-flow impact of “re-imaging” contrasts with the standard corporate view that such investments are vital to keep brands relevant and contemporary.

McDonald's push to modernize and remodel has some operators feeling pinched.

This proprietary survey, which Kalinowski has conducted with McDonald’s franchisees since June 2003, involved 30 operators. Significantly, all 30 answered “No” when Kalinowski asked, “In your experience, is the typical McDonald’s franchisee’s 2012 cash flow growing at a commensurate rate with that of a McDonald’s shareholder return?”

Said one, “Major Remodel Projects are wiping out our cash flow and our equity.” Another explained, “We are bankrupting the system in the name of ‘rebranding’ the system!” Another counters that, “Cash flow is trending up, but not as fast as McDonald’s cash flow is.”

It’s not just remodeling requirement that have some operators unhappy. Several cite McDonald’s discounting program, such as $1 beverages and the Dollar Menu, at a time when food costs are rising. Said one, “McDonald’s Operators cannot absorb all these costs, do all this discounting, and still pay to remodel our landlord’s (McDonald’s) building.”

Another view: “Going south fast. Commodity increases along with construction project upgrades are draining whatever cash flow we might bring in. The Dollar Menu has limited our ability to cover these costs by raising rest of menu prices. This has created a huge gap between high- and low-end, driving more consumers down to supposed Extra Value Menu items which have no useful upside profit potential. Next year projected service cost increases (insurance, utilities, tech fees, etc.) are going to be a backbreaker. Just increasing Transaction Counts is not going to work if they are unprofitable ones. We have created a scenario of working harder for less. There needs to be a window of time to just make profits without giving them all back.”

Few seem to see improvement on the horizon. Said one, “With rents going up, and the push for Major Remodel Projects and replacement of perfectly good equipment, the push for higher amounts of crew and management, due to RDM [Restaurant Department Management], look for labor to take a big jump. Slowly but surely, the equity is going down. ObamaCare will cost my company $300,000 to $400,000 for insurance, taxes, and penalties. When brought up to McDonald’s, about what we can do to offset, they don’t have an answer.”

Dollar Menu discounting also vexes some franchisees.

McDonald’s Corp. will announce its third-quarter results before the market opens on Friday, Oct. 19, and Kalinowski has raised his same-store sales forecast for the brand from 1.5% to a 2.7% increase (versus a consensus of 2%). Janney has a Neutral rating on McDonald’s stock. But while he believes McDonald’s September sales exceeded Wall Street expectations, Kalinowski reports that his survey finds a less positive view of October.

Although September comps averaged +2.7% for these franchisees, October same-store sales are projected to be just +0.7%. Franchisees’ business outlook for the next six months averaged a 2.27 (with 2 being Fair and 3 Good). Kalinowski says this is “meaningfully below the 3.0 average result over the history [since June 2003] of the survey and also below the 2.87 showing from three months ago. It is far below the all-time best-ever score for this question, a 3.46 figure from February 2004. The lowest-ever score stays at 2.12, from December 2009.”

For September, the best result came from McDonald’s franchisees in the West, who reported a 3.7% increase in comp sales. The Central region average, in contrast, was a 1.6% increase. Similarly, West operators see a better October, but it is just a 1.8% boost. Both the Central and East regions forecast 0.3% comp gains.

2 comments to Remodeling, Discounting Vex McDonald’s Franchisees

  • Mike

    I worked for McDonald’s in management for many years until recently. The upgrades to stores are great but it is the food that needs the upgrade. McDonald’s food has declined in taste and quality over the years and they really only attract low end value customers. They should focus on food

  • Keep on downsizing that fish filet, I’m at 5 bites now, used to be 8 bites….when you get to 4 I say no more !! Tired of getting ripped off by business who downsize everything and keep the price the same or even raise it.