Tag: MCD

Fast Food – Signs that a corporation is in trouble

Whether it’s Tim Hortons (TSX: THI), Wendy’s (NYSE: WEN), Starbucks (Nasdaq: SBUX), etc., fast food is a big business. There are winners and losers and the game is mostly zero-sum. Finding the losers at any point in time is much better than finding the winners – at least you’ll know who to avoid.

The most recent trend that I can discern in the industry is the trend toward customization and “quality” fast food. Specifically the winners of the new tastes in customer trends appear to be corporations like Chipotle Mexican Grill (Nasdaq: CMG) that, judging by their $700/share price and $22 billion market valuation, have valuations that are trading in the stratosphere. It hit the magic formula by going for a territory that was previously covered by independents (mainly the truck-side stands in the USA where you can get a good burrito for a few bucks made by actual Mexicans of unknown immigration status), “quality” (just observer all the health propaganda about organic this-and-that), and customization (e.g. this Youtube video of some guy visiting an international franchise in London, England is a fairly good example). Results: the hopes and dreams of short-sellers crushed into oblivion. (Just pull up the rocket ship known as a 5-year chart of CMG and you will see what I mean – they’ve done twice as well as Amazon!).

Franchises like Five Guys and Fatburger are all in the same zero-sum space for burgers, which is a much more competitive environment. You also have Burger King (going through the pains of integration with its Tim Hortons merger), and you have McDonalds.

However, this post was not about the winners, it is about the losers.

And that, for today (and definitely not for tomorrow), is McDonalds.

My attention was swayed by a very brief Marketwatch article about their new marketing campaign, and specifically the following:

McDonald’s released its 2015 Super Bowl ad which spins off the long-running “I’m lovin’ it” campaign. The ad shows customers ordering food. When the cashier rings them up, the cashier ask customers to pay by an act of love rather than cash.

The “Lovin’ Act” extends beyond your TV screen and to actual restaurants. Between Feb. 2 and 14, randomly selected customers will be asked by each store’s “Lovin’ Lead” to execute an act subject to the lead’s discretion. 100 customers per store will be chosen to win throughout the duration of the promotion.

The amount of cultural damage that must be going on in McDonald’s at the moment to allow such a marketing campaign to hit the public must be immense. They already recently fired their CEO (a positive step) and hopefully once the marketing people have had a chance to analyze what a disaster this campaign is going to be, they will actually settle down and concentrate on what they were always supposed to be good for: reliably inexpensive fast food. Maybe by firing their marketing team that conceived of their last campaign, they can save on future costs.

Those familiar with the history of fast food companies will remember the similar slump McDonalds went into 2001-2003 where they finally snapped out of their dementia. Other fast food chains have gone into similar states over the past decade, notably Domino’s Pizza’s (NYSE: DPZ) mea culpa confession that its product tasted like cardboard, and Howard Schultz coming back to Starbucks to get the corporation to realize that people came to Starbucks for coffee and not breakfast or lunch sandwiches.

Interestingly enough, I think Wendy’s is also executing correctly on a turnaround and is eating McDonalds’ lunch. I’ve been eyeing them back since early 2014 and while I am very unlikely to purchase any common shares at current values, I do find this space to be fascinating from a business and marketing perspective.

Tim Hortons, McDonalds, Wendy’s and branding

Tim Hortons (TSX: THI) dodged a lawsuit concerning the methods that it uses to bake goods and cost allocation between franchisees and the parent company.

The key quotation is the following:

Under what’s known as the “Always Fresh Conversion” several years ago, the company stopped making baked goods from scratch in each location every day, and instead started shipping partially baked items that had been flash frozen before final baking in ovens at all Tims locations every morning.

This “several years ago”, to my own experience was nearly a decade ago. While I was not a huge consumer of doughnuts to begin with, they were good for parties and the like. After they did this conversion I no longer purchased them and notably did not find any substitute products that were baked of sufficient quality that I could go to.

I’m somewhat surprised that Tim Hortons is able to retain such a high amount of customer share despite the perception of product quality being somewhat worse than McDonalds (NYSE: MCD). Financially, Tim Hortons is quite well managed, with them reporting a 2011 fiscal year earnings that was about 11% better in operating income than in 2010 (adjusting from a one-time gain from the sale of their bakery). Their balance sheet is relatively clean, with a year’s worth of income of long term debt.

They do appear a tad expensive, with a valuation of 22.5 times 2011 earnings.

The lesson for investors is that product branding is a very strong intangible asset of a business. It takes more than flash-frozen not-so-fresh doughnuts to turn off consumers and their fast food habits.

I guess my sour grapes is still remembering staring at my computer screen in 2003 and seeing McDonalds trading at $15 a share and thinking that despite its operational woes at the time, the company was worth purchasing. The original parent of Tim Horton’s, Wendy’s (NYSE: WEN) just doesn’t have the allure at current valuations either – their branding is much, much less valuable. Everybody around the planet knows about McDonalds and this is what makes their brand so powerful.

Coffee competition

Tim Horton’s (TSX: THI) is finally getting into the latte race with Starbucks and McDonalds.

By coffee, we are differentiating between two separate products:
1. Drip-coffee: Served everywhere. Most corporate offices have a “coffee machine” that does this. Typically, a bag of pre-ground coffee is opened and put into a coffee filter and hot water is run through it to produce coffee. Add some cream and sugar for taste (which is usually required to diffuse the generally mediocre quality that is produced) and you have a product. Sold for about $1.20/cup at McDonalds and about $2/cup at Starbucks.

2. Espresso-coffee: Whole coffee beans are ground at the moment of preparation, compressed into discs, and hot water with pressure is run through these “espresso pucks” that deliver a few ounces of coffee-infused water. This is mixed typically with milk to produce lattes and cappuccinos. This has been Starbucks’ domain for a very long time, but McDonalds recently and today Tim Hortons have been getting into the game. Sold for about $4-4.50/cup at Starbucks and about a dollar less at McDonalds.

In terms of costing, the making of espresso has been transformed into a push-button system with the advent of automated espresso machines. You can buy one at Costco or any other place that sells appliances; a good quality automatic espresso maker will set you back over a thousand dollars (e.g. DeLonghi). Disclosure: I own one of these machines – once you get one, it is very difficult reverting back to regular drip coffee!

The preparation of espresso requires somewhat more product (beans in proportion to the liquid produced) and milk, but otherwise espresso products are very high margin which would explain the major players getting into that space.

I am not sure this is such a smart business decision on Tim Horton’s part, mainly because the target demographic for Tim Hortons is different than that of Starbucks. McDonalds also got into the market recently and I do not believe it was a good decision for them either – it muddles up their product offering. I should also disclose that I have not tried a latte at McDonalds or Tim Hortons, but eventually I should get down to doing some “product research” of my own to see how it compares to my own homemade product.

One other side note is that I generally stopped going into Tim Hortons when they reverted from fresh-made doughnuts to pre-frozen doughnuts. The product quality generally went downhill from that point forward as they tried to corporatize and make their operations into a more consistent manner – they likely determined that making fresh doughnuts caused too much variability between individual franchises.

My last note is that if Tim Hortons really wanted to compete in this market, they should price the product as the same or ever so slightly higher than their regular drip coffee.