McDonald's Dollar Menu threatened
Posted
Jul 24 2008, 01:07 PM
by
Anthony Mirhaydari
Rating:
Rising food and energy prices are forcing McDonald's to take aim at its popular Dollar Menu. "In this current environment, we've got to make sure we're pricing smart, not just pricing low," COO Ralph Alvarez said as the chain reported better-than-expected quarterly results.
For hurried moms, nocturnal teens, lunch-run dads, and anyone who appreciated the food-inflation hedge of one dollar double cheeseburgers, the news comes as a super-sized disappointment.
Investors should be worried too. Unless the company refocuses on its premium, more healthful lineup -- giving the target demographic of its premium beverages a complementary meal option while providing a nice boost to profitability -- shareholders are in for a rude awakening.
Although the Dollar Menu only generates 14% of the company's total sales, it's a big driver of store visits and a key piece of the company's low-cost image. Just two months ago, CEO Jim Skinner proclaimed that passing costs on to consumers wasn't a good idea for just this reason. "They have long memories," Skinner said of McDonald's patrons.
The company hoped that vigorous use of derivative contracts on key inputs like beef, as well as strong overseas results, would allow the company to absorb some of the margin pressure while preserving store traffic. My guess is that they also expected the much-touted, high-margin specialty coffee rollout to compensate as well -- which is part of a wider beverage initiative that includes smoothies, energy drinks, and bottled items. Word on Wall Street is that its lattes and cappuccinos aren't meeting sales expectations.
McDonald’s had no choice but to surrender to the forces of inflation because ranchers are setting the stage for big-time increases in meat prices by cutting down herd sizes in response to unaffordable feed costs. Also contributing is Russia's recent ban on beef from Latin America, further increasing demand for U.S. beef exports due to a weak dollar.
Management is looking for beef prices to increase upwards of 9% this year, with chicken prices up 6% and cheese prices moving 21% higher. Back in April, the expectation was for beef prices to remain flat though the rest of 2008. Beef is the company's largest cost of goods sold expense, standing at 15% of total.
This is all quite unfortunate, since McDonald's steadfast resistance to major price hikes helped capture cost-sensitive business from casual restaurants and drive share performance during trying economic times. But margin contraction has individual franchise owners screaming for relief: Locations in Georgia have bumped the price of some items to $1.09 in response.
To make matter worse, political pressure continues to build against McDonald's and other fast food restaurants for their contribution to rising obesity rates. A Los Angeles city-council woman proposes a ban on the construction of new quick-service restaurants within a 32-square mile section of the city.
McDonald's shares reflect too much optimism for Deutsche Bank analyst Jason West, who downgraded the stock as "risks to the downside are building." Bank of America's Joseph Buckley notes that the company looks increasingly vulnerable to U.S. macroeconomic pressure, and sees elements of investor complacency.
(Disclosure: I don’t own shares in any of the companies mentioned)
Related reading:
Insiders bail as McDonald's brews trouble
Casual restaurants burned by inflation
