John Lynch: 'McDonald's goes digital to put extra bite in its burger business'
Shares are trading close to a five-year high
I watched a remarkable television programme a few weeks back entitled 'The $300bn Burger Business' which invited viewers to go 'inside McDonald's'.
It was a worthwhile journey, not least because of the light it shone on the enormous scope and reach of the fast-food king. The documentary also showed that McDonald's, in the three-quarters of a century in which it has been flipping burgers, has progressed in surges.
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It achieved its original aim of getting the speed and accuracy of a precision-belt into its catering business, and some brilliant marketing innovation produced its own bit of sparkle down the decades, helping the company to always stay a bright idea or two ahead.
The group's latest idea is to buy a new artificial intelligence offshoot that proposes to bring a digital element into the fast-food game. In future customers won't just be faced with the simple choice of a beef patty or chicken nuggets; menus that greet customers will be altogether more flexible because they will be chosen by an algorithm to reflect things like the weather, the time of day, nearby events and historical sales data.
This purchase of an artificial-intelligence company, an Israeli outfit called Dynamic Yield costing $300m (€267m) is its most expensive purchase in more than 20 years and illustrates how important it is to the resetting of the McDonald's business model.
It will also mean significant changes for many of the McDonald's outlets around the world and the 70 million customers it claims to serve each day. The most recent annual sales figures show group turnover at $21bn, while net income is almost $6bn, with a market capitalisation of $142bn.
The present business model of McDonald's is quite simple. It owns the freehold land and buildings of its outlets but the bulk of capital investment including equipment, seating and signs are the responsibility of the franchisee.
For this the franchisee receives a 20-year tenancy but pays rent based on sales, royalties and is responsible for operating costs. Surprisingly, real-estate ownership is a major component of McDonald's business and some investors are of the opinion it should unlock its considerable property portfolio, estimated to be worth between $16bn-$18bn. This view is not favoured by the management.
Like all great companies McDonald's needs to be occasionally reset. The appointment in 2015 of UK-born Steve Easterbook as CEO was the signal for an aggressive transformation and increased profits. He has pivoted the company away from owning its own outlets to a greater use of franchisees.
Today, company-franchised outlets account for 91pc of all McDonald's outlets. This shift in the mix has seen total revenues decline but margins and profits jump, cash flow improve and capital expenditure fall, a combination loved by investors.
He also tackled its product offering, introducing healthier options, smartened-up outlets, and focused on emerging markets and a $500m cost-savings programme. Most of the time in the burger business, size matters, but not all the time.
Last year the burger giant lost to a challenge from Galway-based Supermac's which claimed it had been hampered by McDonald's use of its trade mark from expanding into the UK and EU. The EU ruled in favour of Galway's David, but the Chicago-based Goliath is expected to appeal.
Fast-food restaurant shares with low capital requirements and revenue growth are investor gold. However, investors should recognise this type of business depends on its franchisees making enough profit. To date McDonald's has had few problems. The group increased its dividend over the last 25 years which adds to its attractiveness. But the shares are not cheap, trading at $192, double that of five years ago.
They are also trading close to a five-year high and while the CEO recently warned the group is facing significant challenges, they are still worth considering but it may be worth waiting for the shares to dip.
Nothing in this section should be taken as a recommendation, either explicit or implicit to buy any of the shares mentioned