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Summary

  • McDonald's same-store sales in the U.S have been sliding.
  • The 18 to 32 crowd are choosing other fast casual restaurants as their first option.
  • McDonald's menu has become too complicated.
  • McDonald's has excellent growth potential in Europe, Asia, and Africa.
  • 66% of McDonald's sales come from outside of the U.S.

The golden arches haven't been as golden for McDonald's (NYSE:MCD) lately, as U.S. sales have been on the decline. For February, global comparable sales fell 0.3%, which is lower than the 0.1% estimated. The drop was led by the continued decline of U.S. sales, 1.4% for the month, worse than analyst estimates of a 0.6% drop. In January, same-store sales in the U.S. were down 3.3%, in December they were down 3.8%, and in November dropped 0.8%. There are a number of factors that have brought about the decline in sales, from the changing diet of the American consumer, to the overly complicated menu, to the fact that MCD customers don't have the money to spend on eating out as they used to.

MCD Menu Too Complicated

MCD once had a simple menu, a handful of burgers, a fish sandwich, a chicken selection, fries, and a selection of sodas. The service was quick and efficient, and one knew exactly what one was getting. Today, the menu is vast, with over 120 different selections. The menu board can be confusing and time-consuming when ordering, not to mention the delays in getting an order from the kitchen to the window.

The company's Chief Operating Officer, Tim Fenton admitted that the food giant "overcomplicated" its menu last year:

"We stumbled a bit last year with too many new products, too fast and we created a lot of complexity."

Last year saw the introduction of the failed Mighty Wings, in addition to McWraps, Steak & Egg Burrito, Fish McBites, Quarter Pounders, Grilled Onion Cheddar, and Hot 'n Spicy McChicken… and that does not include its Dollar Menu & More, which offers five new burger choices.

MCD menu is now in complete contrast to its origins and to what has become popular in fast casual restaurants, such as Five Guys or In-N-Out Burger, where the menu is simple and efficient. Mr. Fenton admitted that the oversized menu has caused speed and quality issues, and had a negative effect on operators, saying,

"We didn't give the restaurants a chance to breathe."

While I'm not sure if adding so many choices was a shotgun approach to bring in customers that are looking for something between fast food and fast casual, one thing is known, and that is when MCD added the Extra Value Menu, it was not designed to help the customer. CEO Don Thompson quite candidly admitted that its Extra Value Menu was not all that customer-friendly:

"To be very honest, Extra Value Menu, while a very solid attempt, was based on mining out additional profitability. From a customer benefit it was not as strong as Dollar Menu & More. Extra Value Menu was really a reformulation of certain products, adding some others just to build profitability."

To correct the mistakes of the Extra Value Menu, Mr. Thompson re-launched the Dollar Menu as the Dollar Menu & More, which adds choices ranging from $1 to $5. Mr. Thompson is banking on the new Dollar Menu & More to help regain consumers' trust and to make the company become more relevant. Mr. Thompson explained the menu

"…gives customers a value ladder of sorts, so that based upon their discretionary spending, they have multiple offers."

The company's previous Dollar Menu accounted for 13% of MCD sales. While the hope was that the new menu would increase traffic, improve margins, and give MCD some pricing flexibility, to date it hasn't seemed to attract the number of customers the company hoped for. But it is early in the new campaign, and a wait-and-see attitude would be prudent.

The Changing Habits of the U.S. Consumer

MCD is still the biggest player in the game, and therefore, has the biggest target on its back. The company has been attacked by health advocates from one side, environmentalists from another, and by the Government-- criticizing the company's supersized meals and its low-wage issues-- from a third. Led by the 18 to 32 crowd, known as "millennials", American consumers are choosing other fast food and fast casual dining restaurants as their first choice. MCD isn't in the top 10 of millennials' favorite restaurants, as they prefer places with locally grown, environmentally-friendly food, including grass-fed beef, and hormone-free products. Millennials also enjoy the ability to customize their order, something that MCD is testing with its "build-your-own-burger" at two locations.

MCD has seen its stock drop over 3% YTY, as American consumers have been patronizing the "hip" or "trendy" fast casual restaurants. Chipotle Mexican Grill (NYSE:CMG), which saw its stock rise 84% YTY (and the company MCD sold its stake in far too early), has continued to see double-digit growth while it expands its concept into Asian cuisine and pizza. Starbucks (NASDAQ:SBUX), which saw its stock rise 25% YTY, enjoyed a 5% growth in same-store sales in the last quarter. Five Guys has grown to over 1,100 locations and continues to expand. Dunkin' Brands (NASDAQ:DNKN), not known for healthy products, has experienced its stock rise over 30% YTY and foresees revenue to increase between 6% and 8% in 2014.

MCD Growing Globally

However, MCD is a global company with locations in more than 100 countries, and brings in about 66% of its revenue from outside the U.S. While Americans have visited the restaurants less, and February sales did drop in Asia 2.6% due to weakness in Japanese sales and the date of the Chinese New Year, same-store sales in January gained 2% in Europe and 5.4% in the Asia Pacific, Middle East, and Africa regions. The company continues to focus its expansion overseas and has success, with Europe selling less-expensive snacks in France and new drinks in the U.K. Interestingly, in Asia, where the company is seeing its best growth, MCD markets itself as a lifestyle choice for the middle class rather than as an inexpensive option as is marketed in the U.S.

MCD expects to spend roughly $1.5 billion to open up to 1,600 new locations overseas, including over 300 in Europe and 300 locations in China. In February, MCD opened its first store in Vietnam. Vietnam has 90 million people, most born after the war ended. The country also has an expanding middle class, with a strong curiosity about foreign cuisine and culture. My guess is that MCD will find success and open arms with its expansion in Vietnam, as Henry Nguyen, the son-in-law of Prime Minister Nguyen Tan Dung, is the company's franchisee in a one-party state. MCD will not be the first of the giant U.S. fast food restaurants to open in Vietnam. Yum! Brands' (NYSE:YUM) KFC has 134 locations in operation and its Pizza Hut has 34 locations.

While both Europe and Asia are strong growing markets, the company is eyeing expansion into Africa, where the continent has seen a rise in the middle class. According to the management consulting firm McKinsey & Co., the number of middle-income consumers in Africa has exceeded the figure for India, and predicts consumer spending in Africa will reach $1.4 trillion in 2020, up from about $860 billion in 2008.

MCD has a market cap of $97.8 billion. Its stock closed on March 11th at $98.78, about 5% below its 52-week high. The company has over 34,000 locations globally. The stock offers a solid annual dividend of $3.24 per share.

Though 2013 was a "challenging" year, the company is very profitable. MCD reported fourth-quarter revenue of $7.09 billion, a 2% increase over the same quarter in 2012, but below predictions of $7.14 billion. Income came in at $1.4 billion, which was flat compared to the same quarter 2012, but resulted in an EPS of $1.40 per share, one cent higher than analysts' expectations. For the year 2013, MCD earned revenue of $28.1 billion, a 2% increase over 2012. Net income was $5.6 billion, giving the company an EPS of $5.55 per share, a 4% increase over 2012.

Conclusion

2014 will continue to be a less-than-stellar year for MCD in the U.S.; it has to focus on rebuilding its name and its customer base in the U.S. if the company wants to stem the sales decline. MCD is looking to expand its breakfast hours, which may cause more confusion in the kitchen. However, revenue for fast food and fast casual restaurants from breakfast items grew 4.8% annually on average from 2007 to 2012, and brings in to $31.7 billion annually. According to Technomic's data, MCD already accounts for 31% of all fast food sales in the morning.

History has proven that MCD is a strong bet over the long run, and it will take time for MCD to right its U.S. sales. And as the company is trying to figure how to stem the declining U.S. sales, it might want to remember the old adage that "the key to failure is trying to please everyone." I think if the company remembers who its customer base in the U.S. is and focuses on a smaller menu that is both efficient and value-priced, while not trying to chase the fast casual high-end market, MCD will turn its sluggish U.S. restaurant sales around. The company has over $2.7 billion in cash and a strong cash flow, so even if it takes some time before the company can turn its U.S sales around, it has the financial ability to weather the storm.

I do like that MCD understands the company operates in a global market, and 66% of the company's revenue now comes from overseas. I look for MCD to concentrate its growth in the new emerging markets of Asia and venture into what may be a future market in Africa. While the stock might be a little shaky for the next few quarters, I think the company will turn itself around-- and people will be "lovin' it" and the stock again in no time. That said, I'd buy on further dips for a better entry point.

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: McDonald's: Americans Aren't 'Lovin' It' Like They Used To