Is Innovation Back At McDonald's?

Sep.25.13 | About: McDonald's Corporation (MCD)

The world's largest fast food company, McDonald's (NYSE:MCD), posted weak August comparable sales results overshadowed by the potential for menu innovation. Aggregate same-store sales grew 1.9% year-over-year on top of a 3.7% gain during the same period during 2012.

August Sales

August sales at McDonald's were volatile across geographies. US same-store sales grew just 0.2% year-over-year during August, which CEO Don Thompson blamed on a "challenging environment." Interestingly, Thompson addressed the challenging environment, which we agree with, rather than blaming a bad economy, which has so often been the case. In fact, we think an improving economy may leave McDonald's at a disadvantage as consumers trade-up and no longer demand as much value.

The opposite phenomenon was borne out in Europe, where comp sales grew 3.3% year-over-year on top of a 3.1% comp growth rate during August of 2012. This runs counter to the rest of 2013 that has been fairly weak in Europe. In fact, same-store sales are down 0.2% year-to-date. Regardless, management noted strength across the UK and France that was offset by weakness in Germany. Europe now looks a bit like the US a few years ago, in our view, so we are confident that sales will remain strong for the rest of 2013.

As for the Asia-Pacific region, sales declined 0.5% year-over-year compared to a 5.7% gain in August of the prior year. Management noted that performance was down across major markets like China, Japan, and Australia. Given Yum! Brands' (NYSE:YUM) poor performance in China during August, we think China may be dragging down results at McDonald's as well. We'll keep a close eye on the country, but we tend to believe the problem is a secular issue in China at this point.

Finally…some innovation?

Overshadowing the August sales results are reports about new product innovation from McDonald's. Not only is the company rolling out its wings nationwide, but the firm will also release a Steak, Egg, & Cheese Biscuit sandwich on its breakfast menu. Though the sandwich registers just 10 calories less than a Big Mac, it is a new item that differs from existing products. This will help drive new traffic into restaurants, as product selection has remained fairly stagnant.

In addition to a new breakfast sandwich, McDonald's is testing a family-sized box meal package. Available as an exclusive promotion with the Kansas City Chiefs at this time, the "Blitz Box" sells for $14.99 and includes 2 Quarter Pounders with cheese, 2 medium fries, and 20-piece order of Chicken McNuggets. This idea isn't revolutionary: just a few years ago, Taco Bell ran a promotion for its $5 box package that was a fantastic value for consumers. However, McDonald's entry into the family style may allow the firm to better position itself to gain sales on large, family style events.

With new products hitting menus, McDonald's is also testing new value menus without the strict $1 price tag. This is one of McDonald's largest issues: consumers are addicted to the Dollar Menu, but franchisees hate the products that weigh on margins and constrain revenue growth. If McDonald's can find a happy medium, we think the company will be better off in the long-term with happy franchisees and happy customers.

Valuentum's Take

McDonald's August same-store sales results weren't great, but we are very excited to see the company engage in new product innovation and work to solve its Dollar Menu issues. Although we would love to see McDonald's new products become blockbuster successes, at this point, we're simply pleased to see the company return to innovating rather than resorting to one-time boosts (expanding breakfast hours).

Our primary concern has been that the innovation well had run dry, but recent news suggests we may have simply seen an innovation lull during the past year. Nevertheless, we believe shares of McDonald's look fairly valued, so we won't be looking to add the company to the portfolio of our Dividend Growth Newsletter at this time.

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.