McDonald's Top Line May Recover

| About: McDonald's Corporation (MCD)

It seems as though McDonald's Corp.'s (NYSE:MCD) meals are no longer as happy for McDonald's customers as they used to be. The company reported lackluster top-line results for FY 2013 as shown in the table below. But what's wrong with McDonald's? The management indicated the issue behind the company's declining sales is the menu, or perhaps consumer sentiment regarding spending on fast food is hurting the company's top-line. The company's new offerings, such as the "Mighty Wings", have not been a huge hit because healthier and less expensive foods are what consumers are demanding. According to FactSet Research, analysts presume profits of McDonald's will grow by only 8% per annum, on average, for the next few years.

Source: MCD 2013 Financial Information

The table above shows that the company's revenue per restaurant from both company-owned and franchised restaurants declined in FY 2013 in comparison to the previous fiscal year. The fast food giant undeniably seems worried about this and has planned some exciting initiatives that I will discuss in this article. I will also discuss the outlook of the company with respect to global expansion potential and the steps the company is taking to avail opportunities.

First let us briefly discuss some of the reasons behind the declining popularity of the McDonald's "Mighty Wings".

Mighty Wings Disappointment

Observers analyze that the cause of the declining popularity of the company's "Mighty Wings" was not the product but its price. The demand for the product did not meet expectations as many fast food consumers are unemployed, underemployed, or otherwise very frugal. Macroeconomic conditions were part for the reason for the product's failure in the market. The following heading will discuss the forecast of economic conditions regarding the restaurant industry.

Economic Conditions with Respect to the Restaurant Industry

The U.S. restaurant industry is projected to grow during 2014 and the industry's sales are expected to exceed $683 billion reflecting an increase of 3.6% from 2013's sales volume of $659.3 billion. This growth will stem from the economic recovery and innovation as the industry focuses on brilliant new ways to meet consumer demand. Consumers disclose they are not using restaurant as frequently as they would like and are waiting for economic conditions to improve.

Overall, U.S. economic forecasts are favorable, indicating economic recovery. Real disposable income is projected to grow, inflation will remain modest, and unemployment will continue to decrease in the coming year. Therefore, NPD forecasts a healthier year for the food service industry in 2014 with visits to grow by 1% and a spending gain of 3% by the end of the year.

McDonald's now generates a majority of its revenue outside of the U.S (see chart below). Therefore, I will also consider the growth prospects of the company from markets outside of the U.S.

Source: MCD 2013 Financial Information

International Opportunities and How the Company is Benefiting from Them

According to Datamonitor, the global food service industry is expected to reach a net worth of around $992 billion in 2014, with a volume of more than 586 billion transactions. Cafés and restaurants are the primary market segment representing over 50% of the total industry value. Regionally, Asia-Pacific occupies around 43% of the global food service industry market share and is expected to grow further. McDonald's is striving to expand its presence in Asia and I will discuss this in the next heading. Rising populations and increasing urbanization are causing a change in lifestyle and eating habits in many countries. More people working in offices and an increase in the number of households with two parents in the workforce limits the time available to prepare food at home. This will trigger an increase in the number of people choosing to dine out.

The world fast-food industry is predicted to make almost $240 billion in 2014 reflecting a 19% increase over the past five years. The market is forecasted to reach a volume of around 249 billion transactions in 2014. Quick-service restaurants are the most significant market segment with a 71% share in the overall market value.

New Restaurants in Vietnam

McDonald's CEO says Vietnam offers an incredible opportunity for the company to expand since it recently opened its first restaurant in the country's major city. McDonald's chose Henry Nguyen as its chief franchise operator in the hastily developing Southeast Asian country. A second McDonald's is planned to be opened in the next three months.

The area has over 90 million people that the company expects to serve and the company sees high growth potential in the area. McDonald's now serves 38 Asian countries including the latest venture representing their first mark in Vietnam where a young population is highly fascinated to have Western-style food and consumer brands. McDonald's plans to open 100 restaurants in Vietnam within a decade.

Since the U.S. still remains one of the dominant nations in the global fast-food market, the company is striving to improve its position in the U.S. as well. The market is driven by the growing middle class with growing disposable income. The growth of the fast-food sector will outperform the restaurant industry and growth in the U.S. especially since top companies are investing heavily in promoting their products to further energize expansion. Burgers are the largest market segment, followed by other products such as pizza, pasta, sandwiches and snacks. Therefore, McDonald's plans to restructure its business model to improve its position in the growing market.

An Alteration in the Business Model May Work

McDonald's has announced it would conduct a test this year that allows people to order customized burgers. The company began testing the impact of personalized orders last year with a "build-your-own burger" concept at a restaurant in California. Through this, the world's biggest hamburger chain is trying to compete with growing chains like Chipotle and Five Guys that provide customers more flexibility in their orders.

The move is aimed to appeal to customers who want better burgers with quality ingredients when eating out. The company's U.S. brand and strategy officer regards this proposal as a "huge driver" for the company's growth that will aid in the recovery of top line. Without indicating precise figures on the sales impact, the officer said it's appealing to a different category of customers and more of a dinner-time crowd.

The testing will be conducted at more than five but less than a hundred restaurants of the company. The additional locations will also be in Southern California.

The test reflects an effort by McDonald's to adapt to the growing trend of customization in the fast-food industry. McDonald's got this idea of modification from the popularity and success of Chipotle and Subway who are following this model and satisfying customers largely due to the fact that people can choose exactly what they want on their burritos and sandwiches. McDonald's is testing custom-made burgers with a range of 20 toppings and sauces.

My Take

Inferring from the positive outlook of the industry and the company's strategic plans, I am optimistic that the company's top line will grow in the coming year. The company is launching its operations in areas with high growth potential such as Asian markets. Additionally, the company is planning to amend its business model taking into account consumer preferences in the U.S. This will support the company in improving its position and allow it to grab a stake in the growing U.S. restaurant market.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: The article has been written by a Blackstone Equity Research research analyst. Blackstone Equity Research is not receiving compensation for it (other than from Seeking Alpha). Blackstone Equity Research has no business relationship with any company whose stock is mentioned in this article.