How Will Rising Ground Beef Prices Hurt McDonald's

| About: McDonald's Corporation (MCD)

Summary

Rising prices in the Ground Beef Market may set a cap on the McDonald's rally.

Food Costs are one third of all operating expenses, understanding price changes matters.

AGCHEQ Ground Beef Indexes are near 5-month highs.

Why Ground Beef Prices Matter to McDonald's Stock

Just as iron ore prices matter for steel makers and crude prices matter for refineries, it's important to keep an eye on fresh food prices for all restaurant stocks.

In purchasing more than 1 billion pounds every year, McDonald's (NYSE:MCD) has exposure to the US Beef Market, specifically ground beef.

According to the AGCHEQ Ground Beef Indexes the Ground Beef Market is rallying. After the late 2015 collapse, prices are approaching 5 month highs, up almost 10% in the last 2 months.

Food Costs Matter to the Bottomline

Across the restaurant industry, food costs contribute the largest percentage of the changes to operating expenses that directly impact gross margins and overall profitability. Even a giant like McDonald's reports that food costs were 32.6% of all expenses in the 2016 first quarter. Moreover, this spending is highly concentrated as 75% of their grocery bill comes from just 10 different commodities.

Excert from MCD Click to enlarge

Unfortunately, it's hard to determine and track what the actual prices are of these highly important top 10 items.

After all, McDonald's restaurants sell "two all-beef patties, special sauce, lettuce, cheese, pickles - on a sesame seed bun"- and known, traded commodities like #2 Soft Red Winter Wheat or Live Feeder Cattle.

Knowing and understanding real food input prices as accurately and precisely as possible is imperative to effectively managing investment risk.

In this regard, when it comes to perishable foods, whether Meats, Fruits or Vegetables, the United States Department of Agriculture does more than just regulate and protect the food chain. By law, USDA reporters record activity at all major beef producing plants and wholesale produce markets.

By aggregating, normalizing and analyzing this USDA metadata, AGCHEQ created accurate cost indices that track the price of all the dozens of important perishable foods real time over a unique platform.

One product that presents the volume weighted average price of the most popular form of ground beef, the AGCHEQ Ground Beef 80-85% Index, shows just how important having accurate market visibility can be to anticipating successful investment returns.

Below are the AGCHEQ Ground Beef 80-85% Index's chart since January 1, 2015 and the MCD stock chart for the same time period. When final goods sale prices are constant, changes negatively correlated input costs - such as ground beef for burgers - go straight to the bottom line.

AGCHEQ Ground Beef 80-85% Index since January 1, 2015 Click to enlarge

AGCHEQ Ground Beef Index Click to enlarge

MCD Stock Daily Price Chart since January 1 2015, Courtesy of Yahoo Finance. MCD Stock Daily Price Chart since January 1 2015, Courtesy of Yahoo Finance. Click to enlarge

These charts demonstrate how the respective moves began in September and are near mirror images of one another. The AGCHEQ Ground Beef 80-85% Index broke down from $2.75 per pound to $1.75 (-36%). Meanwhile, MCD rallied from approximately $95 to briefly over $130.

CORRELATION

Over the last 22 months, the AGCHEQ Ground Beef 80-85% Index has had a r-squared correlation of 0.86 to MCD stock performance.

AGCHEQ Ground Beef 80-85% Index vs MCD Click to enlarge

Click to enlarge

Time will tell whether the bottom holds in this and other AGCHEQ Ground Beef Indexes and prices continue to rise. If so, that may also mean the 52wk high is already in for MCD.

Disclosure: I/we 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. I have no business relationship with any company whose stock is mentioned in this article.

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