In an attempt to consolidate its breakfast segment, McDonald’s Corporation (NYSE:MCD) is testing new breakfast pastries at its outlets in San Diego. ((Report: McDonald’s tests new breakfast pastries)) The items, known as Petite Pastries, are available in raspberry and cinnamon cheese cream variants, and cost $1.99 – a price point most customers are comfortable spending for their breakfast. McDonald’s decision to test breakfast pastries also resonates well with the company’s attempt to put a greater emphasis on coffee. Late last year, the company announced that generating more coffee-driven visits will be one of the focus areas in the next 2-3 years. McDonald’s drip coffee is popular but there is a scope to increase the sales of its espresso and specialty coffees.
Taco Bell has been hitting the headlines lately with its plan to foray into the breakfast segment, with the addition of Waffle Taco, A.M Crunchwrap and Cinnabon Delights to its menu. These items will be available on a nationwide basis from March 27 onward. Similarly, Starbucks has also added breakfast sandwiches such as Ham And Swiss Croissant and Ciabatta With Vegetables, Egg and Fontiago Cheese to its menu during March.
Restaurant chains often test new products in select markets before extending the items on a nationwide basis. Taco Bell tested its breakfast items at 850 stores for more than a year and a half, before deciding to roll them out at its 5,500 stores across the U.S.
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We have a $99 price estimate for McDonald’s, in line with the current market price.
Breakfast Segment More Competitive Than Ever
Restaurant chains are increasingly being lured towards the breakfast segment since it is one of the bright spots in an otherwise stagnant restaurant industry. Guest traffic during the breakfast slot rose 3% in 2013, while traffic during the lunch as well as the dinner segments decreased 1%.  One of the reasons for this increase in morning traffic could be the declining unemployment level, which might be forcing more people to wake up early, in addition to putting more money into their pockets.
McDonald’s is the dominant player in the breakfast segment with a market share of over 30%.  The company generates close to $10 billion in sales solely from the breakfast segment, which are almost a third of its U.S. sales. Over the years, a number of restaurant chains have introduced their breakfast menus, but none has been able to match the success of McDonald’s. However, Taco Bell has been able to create a significant amount of hype and is being looked as a player that could succeed in the long run, if not match McDonald’s.
McDonald’s Needs To Protect Its Morning Share
Due to high reliance on breakfast for its sales, McDonald’s needs to protects its share of the breakfast segment. Moreover, the company is struggling to compete with fast-casual restaurants such as Chipotle and Panera Bread during the lunch and dinner time slots. Any deterioration in breakfast sales will inadvertently affect the cash flows.
McDonald’s has posted a series of disappointing sales figures in the last one and a half years. Same-store sales could only rise 0.2% during 2013. The start to 2014 has only been slightly better, with sales up 0.5% through February.  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 fluctuations.
As mentioned in our previous article, McDonald’s valuation can erode as much as 10% if McDonald’s loses share in the breakfast segment. Low sales would not only result in thinner margins, but would also incentivize the franchisees to renegotiate their long-term royalty rates with McDonald’s.Notes:
- NPD: Breakfast led restaurant traffic growth in 2013, March 11, 2014, nrn.com [↩]
- Taco Bell to Take on McDonald’s Breakfast With Eggs in Waffles, February 24, 2014, bloomberg.com [↩]
- MCD 8-k [↩]