McDonald’s Gobbles Up Growth In May But Concerns Remain

Sales of McDonald’s Corporation (NYSE:MCD) finally showed signs of normalizing as it registered a 2.6% growth in the same-store sales in May. In the U.S., the figure rose by 2.4%. ^[1] Prior to May, McDonald’s had failed to register a sales gain of more than 1% for five consecutive months in the U.S. Last few months had been tough for the world’s largest fast food chain since the results had come on top of a high base. A warmer winter last year had resulted in better-than-expected sales.

With the onset of summers, the sales growth was naturally going to improve. 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. While this is certainly a positive development, it still highlights the same problem McDonald’s has been facing for a while: not generating high enough sales despite a greater emphasis on lower priced items such as the Dollar Meal.

It’s no secret that McDonald’s margins are getting hurt due to an increased dependence on value meals. Margins of the company-operated stores shrank 90 basis points to 17.8% in 2012 and dropped further to 16.2% in the first quarter.  ((MCD 8-k)) Although it can vary from one chain to another, restaurants generally need a comparable sales growth of ~3% in order to offset the rise in commodity, labor and occupancy costs. Therefore, the margins could continue to remain under pressure if McDonald’s fails to improve from here. While the figure of 2.4% in the U.S. isn’t bad, it is not worth boasting either. Even the American economy is in a modest condition right now, so the macroeconomic environment cannot be solely blamed for the tepid sales figures.

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Intense Competition

Although this industry has always been competitive, McDonald’s is at a disadvantage since it doesn’t have much scope to expand nationally. Some of the other restaurant chains such as Taco Bell, Dunkin’ Donuts and even Chipotle are expanding to regions where they have traditionally had a low presence.

McDonald’s has 14,000 restaurants in the U.S. compared to 5,700 for Taco Bell and 7,500 for Dunkin’. The former plans to add 2,300 new stores within the next eight years while the latter aims to double the store count in the U.S. to ~15,000 by 2020. Thus, McDonald’s sales could get hurt since the newer restaurants generally have a novelty factor associated with them. For example, Dunkin’ Donuts has no presence in California presently, so when it opens its store in the nation’s largest state in a year or two, it is likely to be met with some excitement. This in turn could drive away some of the customers of McDonald’s to newer names.

we have a $96 price estimate for McDonald’s, which is about 5% lower than the current market price.

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1. McDonald’s May Store Sales Rise as U.S. Gains, June 11, 2013, bloomberg.com [↩]