McDonald's And Darden Court Customers With New Menu Items And New Concepts

Includes: DRI, MCD
by: Glen S. Woods

The casual dining business has taken some big hits as fewer people are eating out due to a weakened economy, and the payroll tax hike has only added to the restaurants' woes. Sales at casual dining restaurants continued to fall: February saw a drop of 5.4%, dwarfing the 0.6% month-over-month decline in January. With the payroll tax taking effect in January, 160 million American workers brought home less money. Employees earning $50,000 a year saw their take home cut an additional $80 per month. Many casual dining restaurants have seen their customers opt for the "fast casual" dining experience, which is generally less expensive, and does not require tipping a wait staff.

Darden Tests Fast Casual To Bring Back Customers

Darden Restaurants (NYSE:DRI), which operates roughly 2000 casual dining restaurants, saw its third-quarter net income drop 18%. The company's most recognizable brands, Olive Garden, Red Lobster, and LongHorn Steakhouse, fell a combined 4.6% on stores that have been open a minimum of one year. For the three months that ended February 24, Darden earned $134.4 million, or $1.02 a share, down from $164.1 million, or $1.25 a share, the same quarter 2012. Darden, in an attempt to revitalize its brand and bring customers back, revamped its menus, launched new ad campaigns, and pushed less expensive special deals. But the efforts have yet to take hold; as Darden sales slipped, competitors like Panera Bread Co. (NASDAQ:PNRA) announced 2013 first quarter earnings will rise 16% to 19% over 2012 first quarter earnings, and Chipotle Mexican Grill (NYSE:CMG), announced fourth quarter 2012 earnings rose 17.2% above the previous fourth quarter.

Both PNRA and CMG are in the "fast casual" dining business, which is the fastest growing segment in the industry. Fast Casual can be defined as a restaurant with food made to order with fresh ingredients, having a limited staff with no waiters or waitresses, and having the average ticket between $8 and $16, and include such restaurants as PNRA, CMG, Panda Express, and Five Guys. To compete with the growing fast casual sector, Darden's Red Lobster has begun testing, in two restaurants, a new fast casual concept from 11 a.m. to 3 p.m. called "pay-at-the-counter" where lunches include a selection of sandwiches, salads, soups and sides, priced from $6.99 to $8.99, and customers place their orders at a counter and a server brings out their food.

Whether Red Lobster can lure fast casual customers to a restaurant built on the casual dining experience remains to be seen. However, Darden, with a market cap of $6.52 billion, is still a very profitable company. Even with the slow sales the stock is up over 11.55% YTD, closing on March 25th at $50.38 per share. The company also offers a strong dividend of $0.50 per share. The company reaffirmed its fiscal 2013 earnings forecast of $3.06 to $3.22 a share. Analysts predict earnings of $3.17 a share. The company still anticipates revenue will climb 6% to 7%. Based on the prior year's revenue of $8 billion, this implies about $8.48 billion to $8.56 billion. On March 25th Susquehanna raised its target price on DRI from $40 per share to $45 per share, while Stephens upgraded the shares to "overweight" from "equal weight," and raised its price target from $52 per share to $60 per share. Also on March 25th Oppenheimer upped its target price from $51 per share to $54 per share, with more of a wait-and-see on the upside while seeing the downside of the stock limited. Though I don't see Darden's stock rising much until the average American can return to casual dining, I do see the stock as a long term hold as the economy slowly improves.

McDonald's Unwraps The McWrap To Attract Millennials

Lately there have been some detractors of McDonald's (NYSE:MCD), the largest fast food chain in the world: The food is too fatty, the sodas are too large, and now the "millennials" are shying away from the restaurants and opting for a healthier experience, with fresher ingredients, in a more socially conscious environment. Millennials are difficult to classify; they've been defined anywhere from the 59 million Americans ages 23 to 36, to the 80 million Americans ages 18-32. However they are defined, the millennials are an important demographic that MCD is actively looking to attract and is now on McDonalds radar. The reason MCD is courting this age group, according to Gary Stibel, CEO at New England Consulting Group, in regards to the millennials,"They're 80 million, but they're influencing the next 80 million, both younger and older."

To attract the millennials, MCD has unveiled the McWrap sandwich, or as the company referred to it in a memo, as a "Subway buster," due to the company's research where it found that young customers were looking for something healthier that just a burger:

…if we did not offer McWrap, 22% of these incremental customers would have gone to Subway.

The McWrap comes grilled or crispy, and in three varieties-sweet chili chicken, chicken and bacon, and chicken and ranch. The McWraps also are less caloric than the larger burgers, as they range from 360 to 600 calories.

The memo commented that:

Our customers are consistently telling us, particularly millennials, they expect variety, more choices, customization and their ability to be able to personalize their food experience.

Millennials still go to burger chains… they just go less often. Millennials made 3.6 billion stops to hamburger chains in the year ending November 2012, which is down from 4.2 billion visits in the year ended November 2007.

While MCD rolls out its new McWraps, it must be remembered that this is a company with 3000 outlets worldwide selling hamburgers. And while trends come and go, and MCD adds and subtracts trendy items to its menu, like salads, coffees, and spicy chicken sandwiches, the people worldwide come back for burgers, which is MCD's core business. And it also should be pointed out that, though it sounds good to eat at the fast casual restaurants where the food is healthier and fresher (or seems to be anyways), as money tightens (as seen with the payroll tax hike), young consumers may well choose more with their wallets and opt for the much less expensive fast food option, which may be why the fast food drive-in burger chain, Sonics (NASDAQ:SONC), saw its earnings per share double in the second quarter 2013.

Even with the weakness in the restaurant industry MCD, with a market cap of $98.5 billion, saw its stock rise over 11% YTD closing on Tuesday March 25th at $98.25, just below its 52-week high of $99.70, and well above its November 16th low of $83.31 after reporting its first monthly drop in sales in ten years. According to I/B/E/S Estimates, analysts on an average expect MCD to report revenues of $28.894 billion and EPS of $5.78 for fiscal 2013; and revenues of $30.744 billion and EPS of $6.39 for fiscal 2014. MCD currently has a P/E of 18.33, and offers a high dividend of $3.14 annually.


As the late sports commentator, Beano Cook, said two things never to bet against, "Russia in the winter and Notre Dame in South Bend." I will add one more: Never bet against McDonald's - period. Food trends will come and food trends will go, but in the foreseeable future, MCD will continue to sell hamburgers to the world, and profits will continue to rise. And when money tightens for the millennials, MCD will be there smiling as they fork over $5 for a burger value meal. I wish I could say the same for the rest of the restaurant industry, but I do not have the same faith. Though I believe that Darden will continue to be a profitable company, I think until more Americans feel comfortable spending money, fast casual restaurant-goers will continue to eat away at the casual dining sales.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.