This morning, McDonald's (MCD) released same store sales for the month of October that largely missed investor expectations, sending shares down 1% (release available here). This report confirmed the fact that McDonald's faces secular challenges to its business thanks to a saturated fast food market in developed economies and changing taste trends towards healthier options.
Worldwide, sales were up 0.5%, missing analyst expectations for 0.6% growth. McDonald's continues to grow slower than inflation and GDP, indicating lost market share as consumers look elsewhere. In the U.S. sales were down 0.8%, against a positive 0.3% estimate. Europe was actually the bright spot, helped by strength in France and the United Kingdom, with 1.9% growth. Asia Pacific continues to be a disaster as McDonald's has faced significant challenges in Japan with sales down 2.3%.
All in all, this quarter was almost uniformly a negative one, except for isolated parts of Europe. From an investing standpoint, it furthers the belief that McDonald's should be looked at like a utility. There is really no organic growth, but investors receive a decent and growing dividend that provides a 3.4% yield. At 17x earnings, there really is not much room for any further multiple expansion, and with revenue growth hugging 1%, earnings growth over the next five years is likely less than 5%.
McDonald's core problem is how to appeal to young consumers who are less interested in existing McDonald's offerings without alienating the existing cost-conscious customers. McDonald's has tried to handle this problem by expanding its menu with additions of lattes and wraps to pretty mixed results. As these results show, MCD isn't meaningfully growing store traffic. If anything, the customer base is flat or slightly lower. These items do take longer to prepare, and longer service time has hindered McDonald's core speed promise, which might be alienating existing customers.
McDonald's still has significant work to do to improve its brand with the "fast-casual" oriented customer that has flocked to Chipotle (CMG) and Buffalo Wild Wings (BWLD) without upsetting the current customer. It seems that adding incongruous menu items has damaged service, annoying more customers than have been brought in. McDonald's should follow the lead of fast food chains who are better dealing with changing tastes. For instance, Wendy's (WEN), which has been growing same store sales more than 2.5% in the United States, has focused on adding higher quality burgers with pretzel and brioche buns. From a service standpoint, the set-up is no more difficult, just a different bun. This type of change keeps existing customers happy while broadening the tent to win new customers who are willing to pay a little more for a burger.
McDonald's has gone from being an industry leader to laggard over the past few years and has been unable to successfully deal with changing consumer tastes by appropriately modernizing its menu. McDonald's has a golden opportunity to revamp the brand with the 2014 Olympics where McDonald's will advertise heavily, though it needs strong products to keep consumers coming. With minimal topline growth and stagnant same-store sales, I am not a fan of McDonald's at 17x earnings and would rather own Wendy's, which is growing sales. McDonald's works as a dividend play, but at $95, the downside risk outweighs potential upside. I wouldn't be a buyer until $85-$88.