Seeking Alpha
Deep value, special situations, long-term horizon, banks
Profile| Send Message|
( followers)  

Something's definitely wrong at McDonald's (NYSE:MCD), particularly in the United States. Monthly same-store sales fell 0.8% year-over-year during November, so total comps increased by just 0.5%. The big question is: why aren't customers returning to McDonald's?

I think the main problem is pretty evident: boredom. McDonald's new products have all been pretty boring. Even the "Mighty Wings" were far from pushing the envelope in terms of innovation or excitement. Sure, Mighty Wings might sell decently well, but it isn't something that draws me into a McDonald's restaurant or drive-thru.

Wendy's (NASDAQ:WEN) has been the polar opposite. Pretzel buns have been around for very long time, but Wendy's Pub Pretzel Burger and Pub Pretzel Chicken Sandwich were the first mainstream manifestations of the broader burger trend in the United States. It's fun, it tastes good, and most importantly, it's different. People really like it.

Burger King (BKW) has followed a similar strategy. Sure, you can buy your ordinary Whopper at Burger King, but the company now offers rib sandwiches, pulled pork, Tendercrisp Chicken sandwiches, chicken parmesan sandwiches, and even veggie burgers! While having so many products may not be ideal for operating efficiency or margins, it certainly does create some intrigue around the restaurants. Comps weren't great in the third quarter, but I would be willing to wager that Burger King outperforms McDonald's in the fourth quarter.

(click to enlarge)

Some of the boredom from McDonald's actually comes from McDonald's incredible success. As we can see from the above chart, comps have been excellent over the past few years. Because of McDonald's tremendous value proposition, consumers have been eating at McDonald's fairly consistently. With the economy improving, I think it is possible that consumers are tired of McDonald's and just want to eat something else.

What can McDonald's do to Improve?

"Think outside the bun."

Well…kind of. I don't think McDonald's should try to deviate much from its existing strategy. Healthy foods have never really caught on at McDonald's, and I don't see that happening ever. Salads currently contribute only 2-3% to total sales according to CEO Don Thompson, so it is hardly important to the overall revenue mix. However, McDonald's could produce some new products like brioche or pretzel bun burgers, and the company should also experiment with new tastes and flavors. McDonald's might simply need to sell some products that access different parts of the flavor pallet.

Still, the company isn't "broken" by any means. It's sales still easily trump its competitors, as shown in the above chart. McDonald's just isn't winning market share. Everything McDonald's does should be framed within the context of providing value, but it wouldn't kill to have some "trade-up" items for consumers that are feeling more optimistic about the economy and want to eat something else.

McDonald's is a long-term hold

At its current price, I'm not crazy about McDonald's because it doesn't offer the same upside as Wendy's. However, the company will add thousands of new restaurants throughout China and other emerging markets over the coming years. In fact, McDonald's is on pace to open 750 new restaurants in its Asia-Pacific, Middle East, and Africa segment in 2013. With Yum experiencing steep sales declines as consumers react to poor cleanliness in Chinese restaurants, McDonald's has a great opportunity to steal some momentum the market-leading KFC.

I think shares are worth about $105, which means there isn't a ton of upside right now. However, McDonald's does have a dividend yield of 3.4%, and the company should continue to grow its payout roughly in-line with cash flow expansion. Plus, it's fantastic value proposition makes it a defensive name that should thrive even in the event of another recession. At $90, I like the name a lot, and at $85, the Golden Arches would be a true bargain.

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.

Source: What Can McDonald's Do To Catch-Up?