McDonald's (NYSE:MCD) decision to introduce all-day breakfast was a huge boost to the company's image and, more importantly, sales. However, the initial success is starting to fade. The big question is, "Now what?" But there might be an even more important implication from McDonald's sales slowdown when you put it into a broader industry context.
A few years ago McDonald's was in something of a funk. Its core U.S. market was a notable trouble spot because it was, basically, stagnant and nothing the company was doing changed that. Until all-day breakfast came along.
It might sound like a small change, but don't underestimate the magnitude of trying to alter the business processes involved. It's one thing to focus on breakfast food during breakfast and then burgers and such during lunch and dinner. It's another to try to do breakfast and burgers at the same time. It could easily have thrown the company's operations into disarray. So McDonald's deserves credit just for being able to pull all-day breakfast off.
That's great, but it sure was nice to see the effort lead to a solid rebound in same-store sales. For example, third-quarter 2015 same-store sales jumped around 4%, fourth-quarter 2015 was up around 5%, with first-quarter 2016 up around 6%. That's impressive and a good deal of the success was tied to breakfast.
However, recently released second-quarter results, with same-store sales growing around 3%, suggest that the initial pop is over and things will get much harder from here. There're two reasons for this. First, as I've noted before, McDonald's doesn't seem to have any big follow-up. Second, once the breakfast pop anniversaries in the third quarter, the company's comparable store sales figures will get harder to beat.
But there's more going on here...
For example, McDonald's CFO Kevin Ozan noted during the conference call that the company's prices in the U.S. were up around 3% year-over-year. That compares to the food-away-from-home average of 2.6%. Worse, the cost for food-eaten-at-home only increased about 1%. Put another way, the cost to eat at McDonald's went up faster than alternatives.
These numbers seem small, but they matter to customers who have to choose between making a meal (or bringing one along from home) and buying food on the go. This is a big headwind to keep in mind, especially as McDonald's faces increasing pressure on its costs. That comes from its own decisions, such as stepping up the quality scale - a must in the current environment. And from outside forces, most notably calls for wage increases.
So for McDonald's you'll want to watch comparable store sales and costs (its costs and the cost of its food) closely. But there's a bigger picture here, too. McDonald's may be one of the largest players in the restaurant industry, but it's hardly the only one. So the cost increases that consumers are facing are widespread. So too are the falling sales comparisons.
More and more restaurants and eateries are turning in weak numbers. For example, Starbucks (NASDAQ:SBUX) has missed sales expectations for three consecutive quarters. That isn't to suggest that Starbucks has fallen out of bed or anything, it hasn't. But clearly it appears to be getting harder for the coffee king to grow like it has in the past and like industry watchers expect.
Chipotle Mexican Grill (NYSE:CMG), facing a host of quality problems, missed analyst earnings estimates last quarter too. And costs are starting to become more of an issue in the company's attempt to lure customers back after its high-profile and embarrassing quality scare. That doesn't bode well for the next earnings report.
Dunkin' Brands Group (NASDAQ:DNKN), meanwhile, missed on same-store sales expectations and on the top line. Although the company cited a few key issues, including pricing its food to high (sound familiar?), there was another comment that stuck out. CEO Nigel Travis explained to Reuters, "There was no doubt there was some kind of mini malaise in the industry."
I could keep going with other weak spots, including sales declines at companies like Del Frisco's Restaurant Group (NASDAQ:DFRG). But the point is pretty clear, as Dunkin' Brands CEO hinted at, there's something going on in the restaurant group. And McDonald's CFO gave a key background fact when he noted that eating costs are going up faster at restaurants than for food prepared at home. That hints at a bigger problem for the entire market.
Is it McDonald's or the economy?
Looking at kitchen table finances, when times are tough one of the first costs to get cut is... eating out. It's just not a necessity. But if times are getting tough enough to have a wide impact on the restaurant industry, particularly the lower end of the space, what does that say about the broader economy?
And that's the bigger takeaway from McDonald's slowing same-store growth. Yes, there's a company-specific component. But there's something bigger going on in the industry as a whole. That bigger picture, hinted at by McDonald's problems, suggests the U.S. economy may not be as strong as some people believe. That could be bad news for McDonald's future, the restaurant industry's future, and the entire stock market.
Disclosure: I am/we are long DNKN.
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.