McDonald’s Continues Its Innovation: Can Fresh Patties Be The Next Winner?

After the success of its ‘All Day Breakfast’ initiative, McDonald’s (NYSE:MCD)  is looking at several other innovations to improve its food quality and promptness in service. The company is conducting a test with burgers made of fresh beef at some of its restaurants in Dallas. While McDonald’s uses flash frozen patties in its burgers which are then grilled in the restaurants later, the experiment at limited locations to use fresh beef has been underway since November last year. The company has not indicated whether this will become a permanent feature or whether it will be expanded to other restaurants.   However, this initiative has the potential to significantly improve the food quality and service at McDonald’s restaurants. Burgers made from fresh patties can potentially become “premium” food items at its restaurants and appeal to the millennial generation preferring “better burgers”. McDonald’s could potentially move up the price ladder with this innovation.  As the company looks at ways to improve its offerings as part of its turnaround strategy, fresh patties can prove to be the next winner for McDonald’s, in our view.

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Moving Into The “Better Burger” Category

According to McDonald’s management, the company has a potential opportunity to move up the pricing ladder as it enhances consumer experience and food quality. Experimenting with initiatives such as fresh beef is bringing the entrepreneurial spirit back into the company and giving it a platform to compete with “better burger” restaurants such as Shake Shack. Expansion of this initiative to other restaurants comes with its own challenges.  The company must address several operational issues for these initiatives to be successful on a larger scale. Internal food safety, consistency , food quality standards and storage requirements for fresh meat need to be met before more restaurants can be brought under this test. However if McDonald’s is able to roll this initiative on a wider scale, it holds a strong potential for the company. These fresh burgers can be “premium” food items at its restaurants and priced higher. This can increase the average spend per customer visit at the company’s restaurants. We estimate this number to moderately increase from $3.35 in 2016 to $ 3.42 by the end of our forecast period.

However, if the average spend per customer increases to around $ 3.80 by the end of our forecast period, there can be a nearly 10% upside to our price estimate.

McDonald’s believes that a larger roll out of this initiative will not require any major new equipment or expenses by its franchisees.  If the customer response is positive and the operational issues are addressed, the company should be able to expand this test rapidly to other regions.  U.S. millennials increasingly prefer burgers with the more flavor fresh beef offers.  Experts believe that the market for premium burgers with fresh beef could see sales doubling in the next five years. Revenues from top end burgers are estimated to double to $ 10 billion by 2021, outpacing growth in regular burgers. Given changing consumer preferences, we believe McDonald’s initiatives to adapt itself to these consumer needs will provide a boost to its revenues in future.

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