Whenever I go out for lunch, Subway is nearly always my default choice. I go because the food is delicious, the service is fast, the location is convenient, and there's enough vegetables that I'm deluding myself that a Steak and Cheese Footlong is healthy.
Meanwhile, I can barely remember the last time I went to McDonalds. (NYSE:MCD) I know the food is unhealthy, so I tend to avoid it. I find there to be a lingering aftertaste after I eat there also, so I tend to shell out a little extra for a burger at Five Guys. I'd glad to pay the $2-$4 difference in price for what I perceive to be a much better product. Plus, Five Guys gives you free peanuts while you wait!
I obviously don't think you should base your investment ideas on my restaurant habits, but are my habits part of an overall trend that can influence investors? Let's look at McDonald's.
My biggest concern is the menu. McDonald's started off with just nine menu items when they opened in 1940, and have since expanded to over 145 different items. Plans are in place to trim the number of items on the menu, but these changes will be minor. McDonald's is trying to appeal to every segment of the consumer market, but isn't doing it very well. Salads are less than 3% of their total sales. Both Wendy's (NYSE:WEN) and Taco Bell, part of Yum! Brands (NYSE:YUM), have released new hit products (the pretzel burger and Doritos Tacos, respectively) in exactly the category McDonald's has been diversifying out of.
Or, to quote Richard Adams, a restaurant franchise consultant, "it's gotten to the point where the operation has kind of broken down and that's all a symptom of the complication of the menu. They can't make the food fast enough." Richard is completely right, and customers are suffering. They spend, on average, over 3 minutes in the drive-thru, compared to 130 seconds at Wendy's and 150 seconds at Taco Bell.
While McDonald's doesn't need to abandon healthy stuff completely, I think more effort needs to be put on the core menu items. Consumers are increasingly telling the company their competitors have better hamburgers.
McDonald's is also messing with one of the only reasons why consumers pick them, by adjusting the dollar menu, pushing prices upwards. While dollar menu sales only made up 15% of the total mix, cheap items are effective for driving foot traffic. It's no wonder McDonald's reported such weak sales in October.
Additionally, McDonald's is starting to suffer from the Wal-Mart (NYSE:WMT) effect, where consumers start to avoid the company because of poor wages paid to employees. McDonald's simply can't afford to pay more, so this isn't going away. All the company can hope for is for the uproar to die down.
Based on the first three quarters of results for 2013 (already reported) and analyst's estimates for Q4, McDonald's is on pace to grow 2013 revenues to $28.14B, a paltry 2% revenue growth YOY. Earnings are on pace to increase some 4%. The company currently trades at a P/E ratio of 17.5, a little rich for a company with such weak growth.
According to the 2012 annual report, McDonald's bought back $2.61B in stock during the year, while issuing an additional $2.28B in debt. While McDonald's debt isn't a concern at this point, I would like to see the company suspend share buybacks and focus on paying down the $13.5B debt.
McDonald's management knows they cater primarily to dividend growth investors now, since growth investors will migrate to other names with higher sales growth. The dividend has grown from $2.05/share in 2009 to $3.12 for 2013, a CAGR of 11%. The payout ratio has crept up from 49% in 2009 to 56% (projected) in 2013, which still leaves the company plenty of room to grow their dividend. This should also provide price stability if we enter a overall bear market.
Overall, McDonald's is a world class company trading at a somewhat frothy price. Revenue growth is going to be difficult as the company deals with stale products and the overall tepid world economy, especially Europe. At this point I'd rate the company a weak hold, and I'd encourage investors to take profits if they're sitting on a large gain.
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.