McDonald's Corporation (MCD) Earnings Call Transcript & Summary

Good morning. David Palmer, Evercore ISI's food and restaurant analyst. I'm here today joined by our friends in McDonald's. It's our pleasure and honor to introduce Chris Kempczinski, President and CEO; and Kevin Ozan, Chief Financial Officer of the firm. Chris joined McDonald's in 2015, overseeing global strategy and business development and innovation. He took over as CEO this last November. Before joining McDonald's, Chris had senior positions in other leading companies such as Kraft, PepsiCo and BCG. Kevin has been at McDonald's for over 20 years, rising through the ranks in the financial area of the firm. Thank you very much for being here, guys.

Thanks for having us.

Thanks, David.

Just a few months ago, the McDonald's 2020 story was supposed to be about the U.S. catching up to the rest of the world in terms of its execution and growth, and obviously, it's been a heck of a curveball thrown at you with the pandemic, and it feels like the U.S. has been leading that reopen lately. So perhaps you can reflect on what it was like when you were taking over as CEO 6 or 7 months ago and comment on the business as you see it today, priorities during the COVID period. But just as importantly, I want to understand how you're thinking about the setup for your business coming out of it.

Yes. No problem. Well, as you know, it's been an interesting 6 or 7 months in the role. And I'm fortunate in the sense that when I came into this position, it was -- the business was performing at a high level. We were, globally, I think, across almost every major market, gaining share. We were in a situation where our franchisees were very healthy from a cash flow standpoint where we had maybe an opportunity was around guest counts in the U.S. And so I was excited to see sort of our beginning of the year in 2020 because we got off to a very strong start in the U.S., particularly around guest counts. Yes. There was some weather and some other benefit of leap year. But overall, we were in really good shape heading into the year. And then as you noted, the pandemic struck, and we had to do a quick audible in basically every single market where we operated. Our system, I thought, did a remarkable job of pivoting, getting our restaurants either changed operationally, in many cases, going to drive-thru and delivery only; in other cases, shutting them down. And we're now through that phase, and you're seeing more and more going to the opening. 95% of our restaurants today are open. And so for us, it's now about accelerating the recovery. And that's why about a month or so ago, we announced a significant investment we were going to be making with our franchisees to go drive the marketing side of the ledger. And we're going to now start the dine-in reopening. We've got about 1,000 dine-ins open in the U.S., and that will continue to grow over time. So it's really about now just getting the momentum back that we had coming into the business.

Thanks for your update this morning, and it looks like the reopening process is really progressing. I'd love to dig into that, how you see the difference between the U.S., Europe and elsewhere. It looks like in terms of the sales rebuild, rough numbers, the same-store sales have been approaching flat in certain markets for those units that are reopening, so fairly strong openings. I'd love to dig into what you're seeing on the reopen by format and by market. So any comments there.

Yes. So in terms of reopening, like I said, about 1,000 in the U.S. It's happening in a, I'd say, pretty measured way in Europe. We're still largely closed on dine-in in Europe, but that will grow over time. I think what we do see is when you do open dine-in, you do get an incremental bump from that. So there's clearly, for us, I think, an incentive and a motivation to get the dine-ins open when we can do it in a safe and prudent way, but it's going to be a slow sort of staging on that one. And a lot of it's affected by what's happening locally with government regulations, but also it's around franchisee feeling comfortable. And I should note, by the way, if you're hearing this banging, a crazy situation where we have a window washer now outside of our office here. We had thought we had adjusted for every possible contingency. We did not check in the window-washing schedule. So I apologize for that, but he's making good progress, and we probably have a couple more minutes here.

Yes. That's good. I mean one of the things I was really worried about or at least bracing for impact on your update today was really the fact that you have a bigger part of your business that's walk-in. In Europe, for example, even where you have drive-thru, you might have half the business in those units that's walk-in. So could you talk to those numbers? I mean what the rebuild has been like in those formats?

Yes. Well, I think it's still important to recognize 75% of our restaurants have drive-thru. And between drive-thru and delivery, you can get to pretty significant numbers in terms of just percent of the mix. As you know, there are some markets in Europe that have a lower drive-thru penetration. U.K. is an example of one of our markets that has a lower drive-thru penetration. But I think so far, what we've seen is the demand is there. And for us, that's probably the most important thing, which isn't just -- is there consumer demand for our restaurants, for our product. And so long as that's the case, then we can figure out sort of the other elements in terms of when we can get the dine-in open. But like I said, I think that's going to be a slower stage process, particularly in Europe.

Yes. The -- I was going to touch on that, that by market, you touched on Australia in your update today as being one of those markets that's doing relatively well. As you think through this COVID period, which markets have impressed you with their resilience? Perhaps Australia would be one. But which ones also are concerning you about their lack of resilience or you're worried about a little bit more of a COVID-related or maybe economic-related hangover from this pandemic?

Well, let me toss that to Kevin. I'll get him in on the action a little bit here.

Yes. It's a good question because things are very different market to market around the world in so many different ways in terms of government assistance, in terms of consumer psyche, in terms of reopening dates and plans. So it is difficult to go say that there's one way that things are working around the world. To your point, Australia has probably been one of the stronger markets, certainly, as they've -- they remained open, similar to the U.S. They've seen big increases in drive-thru business, and they've been kind of consistently remaining positive comp sales. Japan would be one of the other ones that has been strong and has remained positive comp sales through this. China, I think, is an interesting country. It's up and down. As you've seen, some cities are getting kind of a second wave of COVID and are shutting down and reopening. So we've seen that before. We're seeing that now with Beijing most recently. So China has been a little bit more up and down, I'd say, than some of the other markets. In Europe, in general, I feel pretty good about most of those markets as they've reopened. Germany, I think, is the one that's probably remained open through this. And because -- part of the reason is because our dine-in business is lower there, we haven't seen as kind of robust coming back at some of the other markets. I think consumers are a little bit more anxious to go out a lot, and so you're not seeing consumers out as much in Germany, as you may be seeing in some of the other countries.

You -- the fact that you're 90-plus percent open in these markets, even Europe now with U.K. coming onboard lately, it does feel like maybe some of the worst scenarios in terms of financial health and financial bailouts, for a lack of a better word, might be off the table. But what are the ranges of things that you're doing for franchisees out there? Obviously, you have some general stuff. But what are some of the extremes?

Yes. I mean, as you know, we talked about on our first quarter call, the most immediate thing we did right away was defer some rent and rent and royalties because we needed to provide some immediate liquidity both to conventional franchisees and our developmental license partners. That was important just to provide them with some certainty because, to your point, a lot of the markets immediately shut down. So they weren't operating restaurants. What you do have, though, is a wide range by country in government assistance programs, in social programs that help the companies and their employees when there are closures. So a lot of the markets in Europe, even when they closed, the employees at least were receiving a high percentage of their normal pay from government and social assistance programs. So there wasn't the same level of concern for how employees were going to survive as there may have been even in the U.S. at the beginning. So in a lot of those European markets, our businesses have been able to withstand a couple of months of closures and not have severe financial impacts. What we do have is we have more individual circumstances, either where we've had some franchisees that maybe took on some additional leverage in the last couple of years as they've done a whole bunch of Experience of the Future projects, maybe purchased some restaurants. So you do have individual circumstances where individual franchisees are potentially highly leveraged that we need to step in and help in some of those individual circumstances. And the other one that we've noted in the release is as reopens start occurring, depending on a franchisee's portfolio of restaurants, they may be -- they may have an inordinate number of their restaurants in travel centers, in travel locations, in malls, in areas that aren't coming back as quickly. And so it's possible that someone who has a different portfolio of restaurants than someone who's got a lot of freestanding drive-thrus, we need to help out in those specific circumstances. So it's really more targeted now. We've talked about assistance now being much more targeted, whereas at the beginning, it was as broad-based. Now it's targeted and temporary to help out individual circumstances, either in specific countries or specific franchisees.

I wanted to dig a little bit back into the U.S. on the reopening. Obviously, you're seeing certain states reopen earlier than others, and you mentioned there's 1,000 dining rooms out of your base in the U.S. that have been opened as well. So those are 2 different things. There's the reopening of the economy, and then there's a reopening of a part of your format. Could you talk about the 2 impacts and what that could mean for sales going forward?

Sure. So when we're reopening the restaurant or markets are reopening, I think one of the things we're spending a lot of time on, both from a customer standpoint but also from a crew standpoint is really around safety. And so we've introduced -- there was some commentary about it a month or so ago, but we introduced a whole bunch of operational changes into the restaurant to ensure social distancing, protective barriers, different cleaning procedures, positioning guides, et cetera. I think that -- we've worked our way through most of that now where I think the training has happened, and we've been able to stand up those operational adjustments. I think what we're now looking at is while us and the rest of the industry, the comp sales numbers are encouraging and that they're getting -- you're showing a real improvement there, the traffic numbers in the industry are still down. They're still down mid-teens. And I think for us, we're not going to be feeling like we are truly back to sort of a business as usual until we see those traffic numbers get much closer to where we were in pre-COVID. And I think, realistically, that may take some time for that to happen, and so it's about how do we stimulate demand, which is what we're talking about on the marketing side, get people more comfortable coming out to our restaurants because they know we have the safety procedures in place and then, hopefully, giving them a great experience so that they're willing to come back.

You -- I can't help but think about breakfast when you make that comment because, to some degree, while it was somewhat expected, the type of numbers you're talking about in the U.S., I am reminded of how much breakfast might be holding you back. I mean that is a daypart that's been particularly hard hit. So I'm sure that's on your mind as you think about the rebuild. And I think you've held back on marketing during this -- during the crisis somewhat. Could you talk about the pace that you can exert yourself and perhaps coax along the recovery?

Right. We've talked about from the beginning of this that we thought breakfast was going to be the most challenged daypart, and that was informed by all of our Experience of the Future remodels where we shut down restaurants, and then we reopened restaurants. And breakfast is a habitual daypart. Once you disrupt that routine, it takes time to sort of rebuild it. So as we went through the pandemic, we absolutely -- and we talked about it on our Q1 call about how we thought breakfast was going to be a pretty challenged daypart. You're right, that as the pandemic struck, particularly in the U.S., we pulled back from essentially all marketing activities in breakfast. It just -- it was going to be a pretty low ROI because we knew there weren't going to be many people out there looking to go get breakfast. So we're now, I think, just starting to turn the lights back on in terms of going after our breakfast business. But when you're looking at daypart numbers at breakfast, it still is down industry-wide, the most of the 3 sort of major dayparts. This is going to be one where I think it might vary a little bit market by market. And so as opposed to it being a broad scale national push that we do on breakfast, I think it's probably going to first start regionally based on just people returning to patterns. But we've got a great breakfast business, and we know a lot of people are interested in going after the breakfast business. And as we said previously, we intend to defend it. So I think it's just making sure we're doing it in a prudent way with -- we need to have customers out there looking for breakfast as a big part of it.

And just as a perspective, in the U.S. right now, the breakfast daypart is more than half of our comp sales decline. Lunch and dinner are relatively flat. Breakfast is obviously driving the overall comp negative.

Yes.

One thing I also wonder about is the -- what you've seen in drive-thru versus -- without dining rooms, my perception is your franchisees are probably making money because they have less labor and you might be discovering how you might be able to do things better in the future just by seeing what you're seeing with the drive-thru. But could you talk -- obviously, you've also streamlined the menu, too. How has this COVID period perhaps instructed you about how you could do things differently or better and then perhaps, what have you missed by having these dining rooms and lack of full menu?

I was talking to a franchisee yesterday who's down in Alabama, and he was telling me one of the big revelations that he and his team have had coming through this is they thought that they were running pretty close to capacity at drive-thru. And they found, actually, they've got a whole another level of capacity that they can get to around just focusing on some of the operational elements of this. And so he said, "It's expanded our view of what's possible through the drive-thru." That said, I think, we're going to make sure that, over time, in a prudent way, we're meeting what customers are looking for. And so limited menu served a purpose for a period of time, but we have to be also attentive to what the customers are looking for when they come to a McDonald's, and I think it's going to vary market by market. It will vary country by country, but we will certainly add things back to the menu. Now whether it goes all the way back to where we were pre-COVID, I think that's probably unlikely, but I think it's equally unlikely that we're going to stay with the current menu because, ultimately, the customer is looking for a broader variety of menu items than what we currently have, and we'll be ready to meet that.

It did seem like you were doing some good things on speed of service even ahead of this. So perhaps they're -- you're showing yourself something in terms of that speed of service to the drive-thru by pushing that much through it.

Yes. We've taken off another 25 seconds in the U.S. off drive-thru times through the pandemic, which is, to me, pretty impressive because it's the only service channel that's open right now. But it gets back to that point. We're learning what's possible and maybe conventional wisdom of how much you could really do from a capacity standpoint. I think we've learned some things about that through this crisis.

And McDonald's was already doing pretty well in terms of market share trends around the world before this. Frankly, we don't know how the informal eating out market is doing outside the U.S. as well as you would know. Could you give us a sense of how you see the competitive landscape playing out? And for example, would you be gaining share as rapidly in these other markets as you are in the U.S. and perhaps gaining share out of the COVID period even more than you would pre-COVID? It would be interesting to hear about the competitive environment.

Some of these markets are going to be difficult because they literally have opened in the last month, and so market share is even an odd concept when you had 2 months in general of a lot of closings in a lot of these markets. Having said that, I think what we may see, what we are probably seeing, in certain markets, you have some smaller local players that, I'll say, you find this a little more challenging than some of us. And so I don't know that everybody similar to potentially even in the U.S. that everybody is going to be able to reopen and thrive post-COVID. In the U.S., there was probably a little bit more of an oversupply. I don't know that we had as much of that issue internationally, but I do think some of the local players that had to close and only have a couple of units potentially will have a little bit tougher time than the companies that have, obviously, broader scale and bigger scale in the markets to be able to operate. So there potentially could be some opportunities from a competitive standpoint for us to expand our footprint, grow a little bit more in some of these countries, et cetera. So we are keeping our eye because each country does have a little bit different competitive and recovery landscape.

Yes. I think no surprise, you -- the greater your exposure to dine-in and the lower your drive-thru development from a competitor standpoint, the more challenged you're going to be. And certainly, with an IEO, the dine-in and casual dine sector, I think, is going to be in at least short to medium term under a lot of pressure. And if you don't have a very well-developed drive-thru component, I think that's also going to be a challenged sector for a period of time here.

Ahead of this fireside, we reached out to clients about their top questions, and one of them was the one we covered, which was international franchisee health. I think that was a concern. The other question we got quite a bit was around cash back to shareholders in the form of dividend. Are you remaining committed to that dividend? And when can you possibly return to share buybacks?

Yes. So I'd say our first couple or top priorities related to capital allocation haven't changed, which our first priority is to invest in the business for growth. That's capital. That's -- in these periods when things first happen, that's providing some near-term assistance to franchisees. That's everything, investing in the business to keep it running efficiently and growing. Second is dividends. We've paid dividends for the last 40-plus years. We know that a lot of our investors highly value dividends. We have a higher percentage of retail shareholders than a lot of companies. We know those folks specifically count on those dividends. So dividends are important, and those continue to be the second priority. After that, what will likely change or what is changing for the near term is we have historically or certainly the last few years, been at 3 to 3.5x EBITDA from a leverage ratio standpoint, depending on which rating agencies method of calculation you use. That's elevated right now for 2 reasons. One, in March, we went out and took out some additional debt in order to make sure that we were well capitalized going into this pandemic. And second, obviously, our EBITDA is down this year, and that's not a great combination for debt to be up and EBITDA to be down. And so in the near term, after investing in the business and paying dividends, we will look to reduce our debt some to get back to kind of our pre-COVID debt ratio levels, which means that, in the near term, we likely will not be buying back stock because we'll use that excess cash to pay down debt in the near term. That would be the one difference, I'll say, versus where we've been the last few years.

And the only thing I would add on that is just, I think, thank God, we had the leverage ratio that we did through this. Kevin and the team were certainly getting pressure to why not push our leverage ratios up. The industry had higher leverage. Thank God, we did because it gave us the degree of maneuvering ability that we needed to support the business, support the franchisees and still meet the expectations of shareholders through it. So Kevin oftentimes doesn't like to say I told you so, but he's feeling a little bit of I told you so on this one.

No. I do think -- I do think these last few months, though, remind us of why it's important to be financially strong. I'd leave it at that, but it is -- we've always thought it's important. It's just been a good reminder why it's important.

That was Kevin just saying I told you so right there. All right. So one of the related questions is about the franchisee spending on capital projects, the reimaging where there is a tail end of that, and obviously, people want to get back to -- want to see the system getting back to unit growth. What are the prospects there?

Yes. So we -- in the first quarter, in our first quarter call, we talked about expecting capital to be down about $1 billion this year, and that's because we kind of stopped 2 things, both Experience of the Future projects, which were primarily in the U.S.; and a lot of the new unit expansion going on, which is more outside the U.S. And that's because, obviously, a lot of those markets outside the U.S. were essentially shut down. There wasn't construction going on. We weren't operating our restaurants. Franchisees, certainly, weren't going to go immediately invest in new restaurants. The plus of what we are seeing actually right now is in the U.S. more so that the franchisees are -- several franchisees are looking to start up again the Experience of the Future projects, which, to me, is a very positive sign of them wanting to invest in the business. So that $1 billion that we thought we were going to save maybe a little bit less than that right now because we have more franchisees coming forward that still want to get their Experience of the Future projects done. So we won't save as much capital probably as I had thought 3 months ago. But I actually view that as a positive because the reason we won't save as much is because franchisees are looking to go back and start reinvesting in the business again. And that, to me, is a good sign of the health of the business, the health of the franchisees and their views on the future of the business.

The only thing I would add on that is I think we're really in a good position coming into this crisis and that the majority of our system was remodeled, has been remodeled. And so I would hate to be embarking on a major remodeling program coming out of the crisis. I'm much happier that we are almost done, and we're talking about dealing with maybe just a couple of thousand restaurants left in the entire system around remodeling. So that gives us, I think, just a lot more flexibility going forward.

And on the new unit expansion, I mean, we took a pause this year, but there's still a lot of opportunity, again, primarily outside the U.S., but there's a lot of opportunity to grow units in our major markets, and we expect to get back to kind of a normal rhythm in 2021.

Chris, I want to talk about digital, you were key architect of that strategy for McDonald's. And there's some other concepts out there that didn't have drive-thrus that had really the gun to their head expand their digital ordering more perhaps by the consumer. But how has this maybe helped your digital mix? How has it helped you think about the digital opportunity going forward? And what are the plans for McDonald's there?

We've certainly seen digital increase through this crisis. We're seeing mobile order pay increase. We're seeing more curbside usage. And I think you hit on a good point there, which is there is a little bit of an inverse correlation, I think, between digital usage and drive-thru penetration. So in markets where we have less drive-thru penetration, like in China, for example, you see really high digital usage. Similarly, you could say, in the U.K., you see higher digital usage; Japan, higher digital usage. So when you get back to what's the value of digital, it's about a convenience benefit, in many cases. Certainly, there's a value benefit comes sometimes with the digital offerings, but it's really about solving customers' need for convenience. And so I think coming out of this, part of what we need to do, and you've mentioned this in the past, and I agree with you on this, right now, what we're doing in digital is -- I think we're doing all the things you would expect us to do, but I don't know if we've turned it into yet a differentiated capability for us. And that's the thing I'm keen to work with the team on coming out of this is how do we really build some differentiation into it. Loyalty is an area that always gets talked about a fair bit. The trick with loyalty is we just -- it can't impede the speed of the drive-thrus. And so how do you design a loyalty program that is improving the customer experience and not slowing down the customer experience. And we've got loyalty in several markets. We're testing it also in other markets. I do expect we're going to have a loyalty program that gets expanded to all of our major markets, but we haven't laid out exactly what that configuration looks like yet.

All right. Ahead of this virus, the U.S. is really humming along, and actually, traffic was doing very well, too. And so perhaps you have a comment on why you think your traffic was finally positive, which was certainly a targeted thing for you. But also, there were some plans for this year. When do you get back to doing the plan, whether that's breakfast, chicken and other?

Yes. So coming into the year, you're right, we were seeing traffic numbers that were pretty strong. And I think what I was encouraged by with that is it was pretty broad-based. So you didn't isolate it. It wasn't like there was just a menu idea that was driving it or it was just a value program. It was everything from speed of service improvements to menu news, to value, et cetera, pretty broad-based, which has given us confidence about its sustainability or durability. You talk about now coming out of this, we had some other plans that were in place. In the U.S., this is going to be up to Joe Erlinger, our U.S. President, working with the local owner operators there to figure out the right time to go do this. So for example, chicken, when you get after chicken, we put those plans on the shelf until we have more visibility. I know they're having conversations about we certainly believe there's a big opportunity for us in chicken. When is the right time to go after that? We had some news that we were going to do around baked goods at breakfast. We put that on halt when you bring those ideas in. So I'd say all of these are live conversations that are going on right now. Part of what the U.S. is also thinking about and talking about is they now have a significantly bigger war chest because of our financial investment that we've made around increased marketing. So where do they really want to go heavy and more to come on that, but as I'm sure you know, the conversations are going on right now.

Yes. I guess when we're thinking about your sales, you mentioned that point about the traffic being down, perhaps breakfast being a part of that. And -- but yet you've had these monster check increases that have been probably family orders. I guess what we're wondering from now on is can you hold on to the good stuff that you've gotten in terms of those bulk orders and maybe the suburban order that's happening? And can you benefit with reopening those dining rooms and hold on? Is there any part of this stuff that's been -- can be sticky, that you can hold on the good stuff as you rebuild that commuter stuff? How are you thinking about the stickiness of some of those things you've gotten as the reopen happens?

Right. Certainly, I think there -- so it's really about are the consumer behaviors enduring behaviors, are they just kind of a moment in time? I think as we think about COVID, there are certainly going to be parts of it that I think are going to be more enduring. So consumers' orientation to more takeaway, less dine-in, more eating at home, I think those are enduring changes to customer behavior. And so I do think that, that lends itself to what you're talking about, family size order or larger check types of orders. I think that will stick to the -- maybe not at the same level, but I think that's going to be something that does continue. The question will just be fast forward 3 years from now, 4 years from now, as things, hopefully, get back to sort of business as usual, do consumers revert all the way back to where they were pre-COVID? That's, for us, the $64,000 question. But I think as we look at over the next couple of years, we think that because COVID is still, in our view, going to be around and a factor in people's thinking, many of the changes that you're seeing right now are going to be certainly enduring through the short to medium term.

Well, we've run out of time, guys, but it's been a great chat. Thank you very much, and all the best until we chat at the quarter. Thank you.

All right. Thanks, David.

Thanks, David.