Mac D’s Faces New Threats on Home Turf

Sonali is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Last month, McDonald's (NYSE: MCD) reported a 1.5% drop in same-store sales for February. Adjusting for the extra leap-year day in February 2012, comparable sales were up by 1.7%. US sales remained unchanged; Europe was up 2.5%; while Asia Pacific, the Middle East and Africa (APMEA) saw a 1.5% growth in sales compared to a year ago.

While the positive international sales is encouraging, flat sales in the US, the primary contributor to the company’s revenue, remains a cause for concern. If we look at the sales figures for the last four years, we find that McDonald's revenue increased by a mere 1% in the domestic market between 2009 and 2012, while sales in the European and Asia Pacific, Middle East and Africa (APMEA) markets increased 18% and 43%, respectively, in the same period. While flattening sales is expected in mature markets like the US, what worries us is competition from new and unexpected quarters.

Price not winning the race for Mac D’s

With the economy remaining sluggish and consumer spending shrinking due to an increased payroll tax hike, discretionary spending like dining out is getting squeezed. At such times, quick service restaurants like Mac D, Burger King and Wendy’s are expected to gain market share from the relatively more expensive sit-down casual dining and fast casual counterparts like Darden Restaurants (NYSE: DRI), Panera Bread and Chipotle Mexican Grill .

However, just the reverse seems to be happening in the domestic market. Though Darden, with casual dining restaurants like Olive Garden, Red Lobster, and LongHorn Steakhouse under its umbrella, saw its sales slip for the February 2013 quarter compared to a year ago, both Chipotle and Panera, leaders in the fast-casual segment, saw their 2012 fourth quarter comps rise around 4% and 5%, respectively. It seems that due to reasons ranging from health to variety, a section of US consumers are choosing to pay a higher price for a fast dining experience rather than tuck into a basic burger at a much lower price at Mac D’s!

New kids on the block

While fast casual has been a growing segment for the past few years, there is a new category emerging which combines the experience and quality of fast casual restaurants with the convenience of a burger joint. And interesting, this category seeks to break away from the basic principles on which Mac D built its world-wide empire – those of standardization and low prices. This segment, comprising smaller players who are no match to "Big Mac" in size and scale, seeks to offer a “better burger” to a nation of hamburger lovers at higher prices. Five Guys, Smashburger and Shake Shack are just a few names who have defined this segment, and new companies are coming up by the day.

What exactly is the pull of the “better burger” versus the basic burger as served by the biggies like Mickey D and Burger King? I believe there always existed a dormant demand for specialty burgers and customers, particularly the more discerning millennials (customers in the 18-32 age group), were ready to pay more for a tastier and juicier or perhaps a different burger.

Or perhaps there is too much of a good thing after all. With a similar-looking Mac D at almost every street, people just want to eat at a different place with an ambiance that is different from the standard Mac D.

Some of the new burger stores are offering "organic burgers," which are striking a chord with the burger lover in the face of the negative publicity Mac D got over the much talked about "pink slime" issue. Other chains have come up with exotic offerings like the ostrich and bison meat burgers, which are tasty and offer variety. These new “better burger” joints are springing up at every nook and corner, and people seem to be lovin’ it! They are eating into the market share of McDonald's, Burger King, Wendy's, and these companies are likely to see pressure on sales in the coming months.

New paradigms

Does this trend signal a structural shift in the industry? I think so. And perhaps McDonald's has got the message as well. I can see two strategies at play at the Big Mac – one is a renewed focus on its Dollar Menu to go back to basics and target the cost conscious customers in these tough times. The other is a move to lure back the adults to its stores with a change in store décor and add its very own specialty burgers and beverages to its menu for the discerning palate. Over the last few years, Mac D has offered innovations like the Cheddar Bacon Onion and McRib sandwiches, and added the much talked about chicken McWrap more recently. The company has also focused on its breakfast business to battle the tough times.

What to look out for?

So am I writing off the company that epitomizes the fast food industry? Not yet. But as we wait for McDonald’s 2013 first quarter results and March 2013 sales report (both slated to be out on April 22), there are a few things that I am eager to find out:

  • Will the March same-store sales numbers look better than January and February?
  • Will the first quarter sales in the US head north finally?
  • Is the international focus paying off?
  • Is the company planning a strategic buyout of any of the “better burger” joints or taking other such direct action to beat the new onslaught?

There is plenty of strength in the stock still, but to be sure time has come to watch for the tell-tale signs more closely and see what Big Mac does to defend its home turf!

Sonali Ray has no position in any stocks mentioned. The Motley Fool recommends Burger King Worldwide, Chipotle Mexican Grill, McDonald's, and Panera Bread. The Motley Fool owns shares of Chipotle Mexican Grill, Darden Restaurants, McDonald's, and Panera Bread. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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