Market Mad House

In individuals, insanity is rare; but in groups, parties, nations and epochs, it is the rule. Friedrich Nietzsche


Can Machine Learning save McDonald’s?

Value investors are asking; “can machine learning save McDonald’s from shrinking revenues?” To clarify, McDonald’s (NYSE: MCD) spent over $300 million to buy the Israeli machine-learning company Dynamic Yield in March.

Dynamic Yield builds algorithms that analyze customer behavior and create personalized user-experiences for individual customers, former employee Mike Mallazzo reveals in a Medium essay. Theoretically, a Dynamic Yield algorithm could examine a customer’s past purchases and create individualized discounts. For instance, an algorithm could offer somebody who buys a lot of Egg McMuffins a free coffee with her next breakfast order.

McDonald’s management’s hope is that Dynamic Yield could help it improve customer service and reduce expenses. I think Dynamic Yield’s algorithms could analyze a month’s worth of orders and tell a McDonald’s manager how many burgers and fries to order.

How Drive-Thru Explains McDonald’s’ Dynamic Yield Purchase

In addition, Dynamic Yield’s algorithms could make customizing meals for individuals easier.

An odd reason for the Dynamic Yield purchase is McDonald’s reliance on drive-thru. In fact, QSR Magazine estimates 70% of US fast-food purchases occur at the drive-thru.

Drive-thru limits customer contact; which makes it hard for fast-food operates to understand customers, or their preferences. The hope at McDonald’s is that Dynamic Yield can provide more information about customers, by analyzing their orders.

Analyzing orders is tough; because McDonald’s claims to serve 68 million customers every day, Wired reports. However, Dynamic Yield is a leader in customer data management, personalization and targeting, recommendations, testing and optimization, and behavioral messaging.

How Dynamic Yield could Help McDonald’s sell more Burgers

Dynamic Yield’s platform could theoretically analyze a customer’s orders, and discover that individual usually buys a Big Mac around 1:30 p.m. on Tuesday.

Consequently, Dynamic Yield could send the person a text or an email with a coupon for a free drink with a Big Mac at 1:00 p.m. on Tuesday. Accordingly, Dynamic Yield has built a “Triggering Engine.” A Triggering Engine is an app that automatically generates and sends emails and push notifications that will supposedly reach customers at critical moments.

Obviously, Dynamic Yield’s Triggering Engine raises serious ethical and legal questions. Is McDonald’s promoting unhealthy eating and obesity by manipulating customers, for example? I predict it will not be long before somebody sues McDonald’s claiming; “the Triggering Engine caused my heart attack by convincing me to eat Quarter Pounders every day.”

Thus, public health experts and doctors should examine McDonald’s’ latest acquisition. Dynamic Yield could make it far harder to encourage healthy eating. Moreover, I predict there will be calls to ban trigger engines and data personalization soon.

Is McDonald’s Desperate?

Value investors, on the other hand, will wonder if McDonald’s is a desperate company. After all, managers do not spend big money on radical new technologies and unproven business strategies unless they are scared.

Shrinking revenue growth rates show that McDonald’s has a lot to fear. In fact, Stockrow estimates that McDonald’s revenue growth shrank for each of the past nine quarters.

For instance, McDonald’s revenue growth fell by 3.357% in the quarter that ended on 31 March 2019. Notably, McDonald’s revenue growth shrank by 11.5% in the quarter ending 30 June 2018.

Significantly, McDonald’s quarterly revenues dropped below $5 billion for the first time in years on 30 March 2019. To clarify, McDonald’s reported quarterly revenues of $5.163 billion on 31 December 2018 and $4.956 billion on 31 March 2019.

McDonald’s is Making Less Money

In addition, McDonald’s gross profit fell from $2.53 billion on 31 March 2018 to $2.536 billion in March 2019. Thus, it is easy to see why McDonald’s is taking such desperate measures – the chain is making less money.

In March 2018, McDonald’s reported an operating income of $2.143 billion and a net income of $1.375 billion. However, in March 2019, McDonald’s reports an operating income of $2.094 million and a net income of $1.328 billion. The drop is small, but it is there, McDonald’s is making less money.

On the brighter side, McDonald’s is generating more cash. McDonald’s recorded an operating cash flow of $2.02 billion on 31 March 2019. In contrast, the Golden Arches reported an operating cash flow of $1.645 billion a year earlier.

Meanwhile, McDonald’s reports a free cash flow of $1.164 billion on 31 March 2018 that rose to $1.528 billion a year later. Additionally, McDonald’s reports an unusual financing cash flow of $220.7 million on 31 March 2019. My guess is that the financing cash is related to the Dynamic Yield acquisition.

In the final analysis, McDonald’s is still a cash-rich company, Mickey D’s reported cash and equivalents of $2.289 billion on 31 March 2019. However, that number was down from $2.468 billion a year earlier.

What’s wrong at McDonald’s?

The cause of McDonald’s woes is easy to guess but hard to pinpoint. To clarify, I blame McDonald’s revenue drop off on increasing competition in core markets like the United States and the United Kingdom.

In the United States, for instance, busy urban intersections often feature several competing fast food outlets. Additionally, American supermarkets like Kroger (NYSE: KR), Amazon’s Whole Foods, and even Walmart (NYSE: WMT) are entering the fast-food business. For instance, Kroger now features delis in almost every supermarket and is adding grills, cafes, and even pizzerias to many of its stores.

Beyond supermarkets and competing fast-food chains, meal delivery apps like GrubHub (NYSE: GRUB) can bring a wide selection of food straight to hungry customers. Consequently, a hungry workaholic never has to leave her desk when she gets the munchies.

How Competitors are Slowly Killing McDonald’s

Meal-delivery apps are a huge threat to McDonald’s because they eliminate the need for trips to the drive-thru. Worse, GrubHub is far more convenient than the drive-thru because you do not have to drive to it.

All the competition and alternatives are inflicting a death of a thousand cuts on McDonald’s. To explain, each new alternative takes only a small percentage of McDonald’s business but the losses add up. Losing a few thousand customers a month or quarterly does not sound bad until you add up the losses at the end of the year.

Worst of all measuring the losses to specific competitors is nearly impossible for McDonald’s. For example, a McDonald’s franchise might lose 10% of its business when Shake Shack (NYSE: SHAK) opens across the street and 2% when GrubHub starts delivery in its area. Meanwhile McDonald’s might lose 3% or 4% of its customers when Kroger adds a pizzeria to a supermarket located a block closer to a busy office park than McDonald’s.

It is impossible for McDonald’s to determine exact losses because Kroger, Shake Shack and GrubHub are unlikely to share their sales data with competitors. Comparing Dynamic Yield data to other numbers; however, could give McDonald’s management a realistic picture of its losses and their causes.

How Dynamic Yield could Help McDonald’s survive

The Dynamic Yield Customer Data Management algorithm could examine a McDonald’s franchise’s sales for two or three years. By comparing sales from different dates, the app could determine which customers are no longer buying lunch at that McDonald’s.

Thus, McDonald’s could change its menu to appeal to those customers. Additionally, McDonald’s could try to contact former customers and ask why they no longer eat there. Ideally, McDonald’s management could learn why the customers have left.

Such data mining is an unproven strategy that carries some huge risks. Customers could see the data mining as an invasion of privacy and turn on McDonalds. As I noted above, public health activists might penalize McDonald’s for trying to manipulate customer behavior. Additionally, competitors could mock McDonald’s for letting artificial intelligence plan the menu.

Is McDonald’s a Good Investment?

I think Mister Market overpriced McDonald’s (NYSE: MCD) at $204.55 on 20 June 2019. However, McDonald’s is still a good income and a nice dividend stock.

Impressively, McDonald’s paid a $1.16 quarterly dividend on 17 June 2019. That dividend grew by 15₵ in 2018 rising from $1.01 on September 18, 2018 to $1.16 on 17 December 2018.

Moreover, McDonald’s has served investors an impressive 42 years of constant dividend growth, estimates. Plus investors received a 2.27% dividend yield, a $4.64 annualized payout, and a 60.7% payout ratio as side orders on 14 June 2019.

Thus, McDonald’s is still a good income stock despite the threats. My advice is not to buy MCD now, but to hold McDonald’s if you own it. I think McDonald’s will be a steady dividend generator for the foreseeable future.