Weak October Sales Suggest McDonald’s Might Be Running Out Of Ideas

by Trefis Team
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McDonald’s Corporation (NYSE:MCD) once again failed to deliver as its same-store sales grew by a disappointing 0.5% in October. In the first 10 months of the year, McDonald’s same-store sales were up 0.3%. While Japan dragged down overall sales in October, what is worrisome is that U.S. sales managed to rise by a mere 0.2%. [1] This piles more pressure on the company as rivals Starbucks (NASDAQ:SBUX), Chipotle (NYSE:CMG) and Dunkin’ Donuts have announced strong third quarter sales.

Comparable sales, or same-store sales, is an important measure to gauge a restaurant’s performance since it only includes the restaurants open for more than a year and excludes the effect of currency fluctuation.

We have a $97 price estimate for McDonald’s, in line with the current market price.

New Additions Fail To Make An Impact

Despite making several menu additions such as Chicken McWraps and Mighty Wings, McDonald’s sales have failed to live up to expectations. Weak same-store sales during the first half of the year were justified since the restaurant chain faced a difficult year-over-year comparison. However, now that the comparisons have eased, continued weak sales are a concern.

McDonald’s is also testing the expanded version of the Dollar Menu known as Dollar Menu & More which will have products priced at $2 or $5, in addition to the regular $1 items. The Dollar Menu represents about 13-15% of its sales but since the food costs have risen over the years, the menu isn’t much profitable on its own. The primary motive behind offering the Dollar Menu is to attract more customers with the hope that they will spend more on other expensive (and more profitable) items. With this expanded menu, the company hopes to leverage the Dollar Menu name to upsell products.

Pressure On Margins

McDonald’s operating margins for company-operated restaurants fell 40 basis points to 18.7% in the third quarter. Operating margins have been under pressure since last year due to a greater proportion of sales coming from lower margin products. Furthermore, weak sales cause the fixed costs (such as labor, occupancy, etc.) to be spread out over a lower base, thereby putting a downward pressure on margins. For the full year, we expect margins to decline ~50 basis points in 2013. [2]

There was also pressure on management to roll out higher-priced items due to growing discontent among franchisees. The excessive reliance on lower-priced products had started to affect the franchisees’ profitability. McDonald’s revenues are a percentage of the franchisee sales. Even if the Dollar menu (or other lower priced products) is able to raise overall sales, McDonald’s might be the only beneficiary and its franchisees could be left to battle low profits. [3].

Despite a string of weak monthly sales figures, McDonald’s shares have traded in a narrow range. This is mainly because a strong brand name combined with the opportunity to expand further into developing markets provides downside protection to the stock even during times when the company is not doing particularly well.

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Notes:
  1. MCD 8-k []
  2. MCD 10-Q []
  3. McDonald’s ‘Much More Controlling’ Amid Slow Sales, Franchisees Complain: Report, August 7, 2013, huffingtonpost.com []
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