Shares of Jack in the Box are down some 20% after the former darling of last year’s “casual burger dining” bubble reported disappointing earnings and cut guidance last night.

In the short term the biggest concerns were the weak same store sales, both at the main Jack in the Box units and the once high-flying Qboda Mexican food unit. Qboda comps rose 1.8% despite the extreme tailwind provided by competitor Chipotle’s widely publicized E. Coli problems. Chipotle comps have down 30 and 36% in the last two months yet Qboda struggled to stay flat.

Red flags don’t come any bigger.

Jack said namesake units were hit by McDonald’s all-day-breakfast initiative. It would be more accurate to say Jack and its peers got stampeded by MCD simply waking up from a long slumber.

Here’s JACK vs MCD from 2012 when MCD posted negative comps for the first time in memory and last year when MCD named a new CEO:

 

 

It was an amazing run and Jack is to be credited for grabbing share from a sleeping giant. Of course it’s easy to win when the competition is unconscious. The trick is not getting stampeded once the giant awakes. On that front Jack isn’t so nimble:

 

 

This is would an outstanding time for Jack to consolidate the gains it can save and dedicate resources to invigorating company concepts. Life in a world where MCD is posting 5.7% comps is much different than the situation 3 years ago when Japanese customers were finding bits of human beings in McDonald’s fries.

To its future shame, Jack is answering the threat of a rejuvenated McDonald’s with repurchases. In fiscal 2015 Jack spent $317m buying shares at an average cost of $84. In Q1 Jack spent another $100m buying stock at over $78. Last night the company said it was adding another $100m to the program.

That puts Jack on pace to spend 4x as much on buybacks as they do on Cap-ex. It’s the worst capital allocation since the French paid for our revolution rather than spending Parisian citizens. Look for a Franchisee revolt by the middle of this year if Jack puts up another quarter as bad as the one we just saw.

I’m playing by staying long McDonalds. No sense making this too complicated.

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McDonald’s is under attack in Europe. An Italian-based labor group is accusing the chain is abusing market power to charge excessive rents to franchisees. The group claims these higher costs are passed along to the consumer.

Via BBC: “‘McDonald’s abuse of its dominant market position hurts everyone: franchisees, consumers, and workers. We strongly urge the European Commission to investigate the charges and to use all of its powers to hold McDonald’s accountable,’ said SEIU organising director, Scott Courtney.”

Since I’m long MCD my inclination is to dismiss the issue as fascist whining. To double check I ran a quick search. An Italian combo meal costs roughly half as much as a meal at an “inexpensive restaurant” and 1/8th as much as dinner for 2 at a mid-range eatery.

 

It comes down to wages. Labor groups want to attack McDonald’s corporate for the same reason Willy Sutton robbed banks, “because that’s where the money is”. Unfortunately for those who prefer their solutions to societal inequality super simple, McDonald’s doesn’t set wages at a store level. Franchisees set wages at the going market rate in each location.

McDonald’s has a wage problem. That’s one of the reasons McDonald’s plans to “refranchise” (read: sell) 3,500 units. By 2018 the company will be 90% franchised in the US. Currently 3/4 of the chain is franchised in Europe, which is MCD largest market because the world loves us. McDonald’s charges franchisees a lot because running a McDonald’s is much more profitable than operating a generic pizza stand. Franchising isn’t as lucrative as it once was but it’s still a hell of a deal.

McDonald’s is much bigger than its rivals but suggesting it has monopoly powers is a reach, even by European standards.

 

In Easterbrook We Trust

I’ve been long MCD since Steve Easterbrook became CEO on March 1st. It was a bumpy start but slowly the ship has turned. Last quarter MCD reported its first comp unit sales increase in the US in 2 years. For Q4 estimates are as high as 3.5%.

I love investing in new CEOs. If they’re good they get about a year where they can report just about anything they want in terms of earnings and still get a pass from Wall St. If they’re great the pass can get extended. It took a while for the Street to warm to Easterbrook but when SSS went positive the laggards got on board.

A little turnaround goes a very long way when you’re operating on the scale of Micky D’s. Over the last 12 months MCD is up 25%. The rest of the group has been charbroiled. Buffett and Ackman’s tax-dodging Canadian Burger King/ Tim Horton QSR has lost 20%. Wendy’s gets included just for being nearly flat. Dunkin’, included because it presumably competes for roadside “gas savings” is down 11%:

 

The European Commission has time to review the complaints and suggest remedies. The EU is also reviewing charges MCD is dodging taxes. If sales were falling I’d be worried. With comps expected to rise in all regions in the current period none of these protests matter.

To things keep me bullish even up 25%. First is the new CEO factor. Second, and more importantly, McDonald’s sells the best consumer product of all time. The salty perfection of the McDonald’s french fry is universal and unique. It can’t be knocked off and it is fully optimized in terms of quality. You can go anywhere in the world and recognize a MCD french fry blindfolded. It’s the same value proposition Starbucks offers, discounted for the lack of addictive caffeine.

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