Why McDonald's is a Strong Sell

Everyone likes a company with a long history of paying strong dividends, but I firmly believe McDonald's (MCD)best days are behind it. The fast-food industry has grown significantly in the 21st century, and McDonald's has benefited from this trend, but the company doesn't represent much upside potential at this point. McDonald's same-store sales fell consistently for 12 straight months until in June 2015 when the company stopped reporting the numbers altogether.

In addition, the company is planning to close more restaurants than it opens in the U.S. for the first time in over four decades.

The company's sales are been hurt by the fact that consumers are willing to spend more money at chains like Chipotle Mexican Grill (CMG) and Panera Bread (PNRA) that sell items for higher prices but promote a perception of healthy and high-quality food.

Clearly, the company is struggling. To make matters worse, many of the company's health-driven additions to the menu haven't been successful. Due to McDonald's brand perception, health-conscious consumers always prefer to eat at chains like Chipotle. However, increasing health awareness isn't the only problem as McDonald's as rivals like Wendy's and Taco Bell have managed to grow sales over the last few years despite serving high-calorie food.

I believe consumer tastes have changed away from conventional fast-food offerings, which is why McDonald's has struggled. It is for the same reason I think McDonald's new All-Day Breakfast initiative will not be enough to reverse the company's fortunes. McDonald's has sanctioned many buybacks and dividends hikes to keep the stock price up, but this strategy isn't a long-term solution.

Too Many franchises?

McDonald's has a heavily franchised business model as the company only owns less than 20% of its restaurants worldwide. While this business model has helped the company to expand worldwide very quickly, it has its drawbacks. Having a heavily franchised business model makes it impossible for a company to ensure a consistent experience for the customers worldwide. This threat was highlighted by Wendy's in its 10-K filing few years ago. The company said:

"While we try to ensure that the quality of our brands is maintained by all of our franchisees, we cannot assure you that these franchisees will not take actions that hurt the value of our intellectual property or the reputation of the Wendy's and/or Arby's restaurant system."

It is because of this treat that brands with high-quality customer experience do not rely on a heavily franchised business model. For instance, Chipotle Mexican Grill doesn't franchise any of its 1,800 outlets and fast-growing companies like Buffalo Wild Wings (NASDAQ:BWLD) are spending millions of dollars to repurchase franchised locations. Earlier in June, Buffalo Wild Wings spent $160 million to repurchase 41 franchises locations, and the company plans to continue repurchasing locations to ensure high-quality customer experience.

McDonald's is too deep into the franchise business model to follow this approach. Not being able to ensure great dining experience for the customers has definitely damaged the company's reputation. With people now willing to spend extra for a high-quality dining experience, McDonald's will continue losing customers to peers like Chipotle and Panera.

Chipotle's same-store sales haven't been extraordinary for the last few quarters due to pork shortage. However, the company recently announced that Carnitas will be back at 90% of its outlets, and plans to have it back n all restaurants by the end of November. The return of Carnitas will see Chipotle growing at the cost of McDonald's.


Although McDonald's has poured money into repurchases and dividend hikes, the company's best days are clearly behind it. Many of McDonald's new menu items have failed over the last few years, and the declining same-store sales is a big headwind. The company can't keep the stock price up forever by hiking dividends. Thus, I think McDonald's is a sell.

Published on Oct 15, 2015
By Ayush Singh

Copyrighted 2016. Content published with author's permission.

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