McDonald's Wings Not So Mighty As Sales Suffer

By Jonathan Berr | October 21, 2013 AAA

McDonald’s (NYSE:MCD), which for years had been a stock that investors would buy and forget about, is not being remembered fondly these days.

Shares of the House of Ronald, fell 61 cents to $94.59 on Monday after it reported sales for the quarter ended September 30 of $7.23 billion, an increase of 2.4%, which trailed analysts’ expectations of $7.32 billion. Even worse, comparable sales, a key metric of stores opened at least a year, are little changed so far this month, according to the Oakbrook, Ill., company. That’s a bit surprising given the heavy promotion for its new Mighty Wings offering.

In a conference call with investors, CEO Don Thompson said Mighty Wings “performed at the lower end of our expectations” because they were too pricey and spicy for some consumers. He added that McDonald’s is improving the product and expects to sell 35 million pounds of wings.

Like every executive of a struggling public company, though, Thompson is asking investors to have patience.

“As the economy does come back a bit, we know that we’ll benefit from that,” said Thompson, who replaced the popular Jim Skinner in 2012. “But we’re also not going to sit back and just wait. We are doing many things tactically to try to address the current environment. But we’re not missing out on the long-term environment as well. “

During the third quarter, global comparable sales rose 0.9 percent, below analysts’ Net income was $1.52 billion, or $1.52 per share. That’s a penny better than expectations. However, operating margins narrowed to 18.7%.

The company’s problems aren’t solely due to the economy. Consumers, particularly younger ones, aren’t patronizing McDonald’s as much as they have in years past. A survey from Goldman Sachs found that the company ranked last among 23 fast food chains in terms of food quality. People also consider McDonald’s to be the least healthy compared with its peers and are the least willing to pay more for its food.

“Simply stated, we must exceed our customers’ expectations for fast, accurate, and friendly service at each and every one of our nearly 35,000 restaurants around the world,” he said. “And furthermore, those restaurants must be clean, well-maintained, and contemporary.”

What he means by that is a matter of debate. McDonald’s franchisees are unhappy about the rising fees that they are being charged for rent among other things as Bloomberg News noted in August. The company charges franchisees at least $800,000 for remodeling, well above the $375,000 Wendy’s (NYSE:WEN) franchisees pay and $300,000 Burger King (NYSE:BKW) charges, the news service says.

For investors, McDonald’s is tough to evaluate. It trades at a price-to-earnings multiple of 17, among the cheapest if not the cheapest of the major restaurant stocks. Its dividend yield of 3.4% also is attractive. But one of the reasons why the shares are cheap is that its growth prospects are limited.

Chipolte (NYSE:CMG), for instance, is expected to increase revenue by 17% this year and sales at Panera Bread (Nasdaq:PNRA) are due to rise 13.5%. McDonald’s revenue, by contrast, will rise 2.4% and Wendy’s is expected to eek out a 0.2% increase. Burger King sales are due to decline by double digits.

The Bottom Line

McDonald's and other fast food companies are in a tough predicament. They have to appeal to both cash-strapped customers, who are their regular customers, and people with more cash to spend. Striking a balance between these very different types of clients is getting tougher. Many of them are choosing to patronize more upscale McDonald's rivals such as Chipolte and Panera.

Unfortunately, Burger King and Wendy's are doing a better job in appealing to McDonald's core value customers. For it to win back these discontented customers, McDonald's is going to have to make better food cheaper, a challenge that the company's hasn't met for years.

Disclosure - At the time of writing, the author did not own shares of any company mentioned in this article.

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