MCDONALD'S

MCD hit its lows in the spring of 2003. Same store sales were declining 4% a month. MCD had been a growth stock for decades. In an effort to keep the growth up, they started to diversify into other restaurant concepts in the late 90's as their markets became saturated and expansion opportunities waned. That strategy failed, as their forays into other businesses never reached critical mass to contribute significantly to the bottom line. Meanwhile, tastes were changing as the population aged and they had their eye off the ball and their core business faltered. New management was brought in, cutoff all the expansion and focused on their core business. They introduced new menu items such as salads to cater to older and healthier tastes, extended store hours, allowed credit cards for payment, etc. Essentially pushing more product through existing distribution channels. It worked. Same store sales started to improve peaking at 13.9% growth in the spring of 2004. So from its low of around $14 a share in 2/03, the stock rallied to 34 1/2 in 3/05. But then same store sales started to settle down, as the comparisons grew more difficult and the stock pulled back to $27. June and July SSS were better than April and May and so the stock bounced back a little to $31. The company itself is looking for mid single digit EPS growth. They fixed the business but are now in the same spot the old management was. How do you get growth out of a large, mature business going forward. They are already the biggest in every thing. They have the largest breakfast business, they expanded their menu, expanded their hours to get the late night crowd. By slowing international and domestic expansion, and eschewing other restaurant concepts, they are back to being a one trick pony, i.e. growing same store sales. This can be seen in the convergence of same store sales figures and total sales figures. The CEO has been quoted as saying that same store sales will be the driver of growth.

In August rumors started flying that Vornado the REIT was buying a stake in McDonald's. They had just done a secondary offering of 9 million shares raising about $800 million. It move the stock $4. At the time, I said it sounds like a lot but consider that in the last six months McDonald's bought back 33 million shares of it''s stock, approximately $1 billion dollars without much affect. I also said that they did not need the cash, that spinning them off into a REIT would provide. They have no major expansion plans. Well last week it finally came out that Vornado did indeed purchase a stake but even smaller than the initial rumors. According to AP they purchased a 1/2% stake amounting to 500 million dollars.

In September the stock was coming back down until it received a brokerage upgrade on rumors of it spinning off its Chipolte unit. I wrote at the time that while this was much more likely than spinning off the real estate, spinning off part of a 435 restaurant chain out of 30,000 was not that big a deal. More important I pointed out was the fact that total sales growth has been slowing on a quarterly basis since the 1st qtr of 04.

Today, they reported their Oct sales figures which were lauded for being better that the street expected, but look at the following table:

• Mthly SSS Total Sales Currency adj Total sales
• Jan 5.2 8.3 6.3
• Feb 1.6 4.4 2.7
• Mar 6.8 11.2 5.7
• Apr 2.8 6.7 3.9
• May 1.8 5.9 2.9
• Jun 3.8 6.2 4.9
• Jul 4.3 6.1 6.0
• Aug 3.4 5.7 4.4
• Sep 3.9 6.3 5.0

• Oct 3.4 3.9 4.4

What jumps out at me is that the trend in total sales growth, which is what correlates to total revenue growth, is really slowing. Secondly, that total sales growth is converging with SSS growth as I expected. Finally,most significantly, currency adjusted total sales were higher than total sales for the first time since I can remember. This means that the strong dollar is hurting total sales. According to their Website, a 10% move in the Euro equals a 6-7 cts per share on their earnings. This is significant considering that a 1% decrease in their SSS equals only a 2% decline in EPS. The dollar is about 13% higher than it was at the start of the year.

Finally both the CFO and CEO in the past couple of weeks have thrown cold water on any kind of REIT spinoff or restructuring. The CFO said it would be expensive and a distraction among other things. The CEO in a letter to employees said they had no intention of a spinoff or restructuring, that it would not serve the interest of their franchises or shareholders. I think he is exactly right. Do you want to lose control of your business by doing some financial engineering to get a one time pop. Spinning out the company owned restaurants so they can compete with the franchised one's is about as stupid idea as I've heard.