Whither McDonald’s

The situation at McDonald’s (NYSE: MCD) should provide a cautionary tale for value investors. Even the best, seemingly sure-fire brands can run afoul of changing popular tastes and customer habits.

The once seemingly unstoppable burger chain is mired in stagnant revenues and declining profits. McDonald’s reported a TTM revenue figure of $27.96 billion on September 30, 2013, the exact amount it reported in September 2013. To make matters worse, revenue at the chain actually declined throughout 2014; McDonald’s reported a TTM revenue of $28.11 billion in December 2013. McDonald’s reported a year to year TTM revenue growth rate of -4.59% on Sept. 30, 2014, and a diluted EPS of 5.098% on the same day.

The Golden Arches Are Not That Golden Anymore

There could be worse things to come at McDonalds in the near future if a press release about the company’s 2014 earnings is accurate. The Golden Arches do not seem to be that golden anymore.

McDonalds itself admitted that consolidated revenues fell by 2% during 2014 in a press release. The same press release contains this disturbing language:

“Global comparable sales decrease of 1.0%, reflecting negative guest traffic in all major segments.”

Other highlights of the press release included:

• A 13% drop in diluted earnings per share.
• A drop in revenues of 7%.
• A drop in consolidated operating income of 20%. The press release blamed this on “weak operating performance in the U.S.”
• A 1.7% decline in in fourth quarter sales in the U.S.
• A 15% decline in operating income in the U.S. in the fourth quarter.
• A 1.1% decline in comparable sales in the Fourth Quarter in Europe.
• A 14% drop in operating income in the fourth quarter in Europe.
• A TTM revenue of $6.572 billion in Fourth Quarter 2014, a definite drop from Fourth Quarter 2013 when it was $7.093billion.

The company that invented fast food does not seem to be able to take advantage of the economic recovery. What’s worse is that some of McDonald’s competitors are taking advantage of the recovery.

Economic Recovery Boosting Fast Food and Coffee Shops

Starbucks (NASDAQ: SBUX) reported a TTM revenue of $17.01 billion on December 31, 2014, a $1.7 billion increase over December 31, 2013, when the coffee chain reported a TTM revenue of $15.31 billion. Starbucks also reported a diluted EPS of 3.03% on the same day as well as a quarterly TTM year to year revenue growth rate of 13.29% on Dec. 31.

Chipotle Mexican Grill (NYSE: CMG) reported a TTM revenue of $3.883 billion on September 30, 2014, an increase of $813 million over September 2013, when the burrito maker reported at TTM revenue of $3.07 billion. Chipotle also reported a diluted EPS of 12.81% on the same day and a quarterly year to year revenue growth rate of 31.12%.

Yum Brands (NYSE: YUM), which operates Pizza Hut, Kentucky Fried Chicken and Taco Bell, reported a TTM revenue of $13.46 billion on September 30, 2014, a $400 million increase over September 2013, when it reported a TTM revenue of $13.06 billion. Yum Brands reported a quarterly year to year to TTM revenue growth rate of -3.23% and a diluted EPS of 3.196 on the same day.

McDonald’s wasn’t the only traditional burger chain in trouble. Wendy’s (NASDAQ: WEN) reported a TTM revenue of $2.152 billion on Sept. 30, 2014, a drop of $368 million from September 2014, when it reported $2.52 billion in revenue. Wendy’s reported a year to year quarterly TTM growth rate of -20.02% on the same day and a diluted EPS of .3426%.

Jack in the Box (NASDAQ: Jack) also reported a slight drop in revenue. Jack in the Box reported a TTM revenue of $1.484 billion on September 30, 2014, down from $1.49 billion in September 2013. Jack in the Box reported a quarterly year to year TTM revenue growth rate of 1.98% and a diluted EPS of 2.123% on the same date.

Red Robin Gourmet Burgers (NASDAQ: RRGB) reported a TTM revenue of $1.106 billion on Sept. 30, 2014, an increase of 8.9 million over September 2013, when it reported a TTM revenue of $1.017 billion. Red Robin reported a quarterly year to year TTM revenue growth rate of 15.91% on Sept. 30, 2014, and a diluted EPS of 2.446% on the same day.

In contrast to McDonald’s, Jack in the Box and Wendy’s, Dunkin Brands Group (NASDAQ: DNKN) has been doing well. Dunkin reported a TTM revenue of $738.67 million on Sept. 30, 2014, an increase of $46.3 million over Sept. 30, 2013, when it reported a TTM revenue of $692.37 million. Dunkin reported a year to year quarterly TTM revenue growth rate of 3.39% on Sept. 30, 2014, and a diluted EPS of 1.48% on the same day.

What’s Going Wrong at McDonald’s?

So what is going on here? Why is a company that has done well for so long in a wide variety of economic conditions having such a hard time maintaining market share?

The first and most obvious culprit is increased competition. There are now a vast number of fast food joints out there serving a wide variety of foods at the same basic price as McDonald’s. Persons that want something besides a hamburger now have many different choices. In some areas, even burger lovers have several different choices at much the same price as McDonald’s.

Changing consumer behavior has also hit McDonald’s hard. The variety of choices has made the American palate more discerning and sophisticated. Consumers are demanding a higher quality of cuisine, even in fast food or casual dining, as the success of Red Robin and Chipotle indicates. People may also be seeking healthier choices.

Another change in behavior might have been driven by falling incomes and increased penny pinching. The lousy economy has made people more conscious of their money and what they spend it on.

A person with just $10 to spend on lunch will think long and hard about what to buy. That individual will be far more likely to shell out money for something of higher quality, such as a Chipotle burrito, than a McDonald’s burger. The penny pincher doesn’t feel as guilty when he buys that oversized burrito.

The lack of discretionary income gives people less money for simple luxuries and eating out. That makes low-cost luxuries like Chipotle burritos and Starbucks lattes all the more appealing. They might be the only really good food a person has all week.

Another problem is that a person walking into McDonald’s and looking at the dollar menu is reminded of the fact that he or she is broke or nearly broke. A person who walks into Chipotle feels a little wealthier because he or she is able to buy a high quality, handmade burrito for $6−$7, or around the price of McDonald’s Quarter Pounder with Cheese meal, according to FastFoodmenuprices.com.

This hits McDonald’s hard when discretionary income increases even slightly. A person with a few extra dollars in his wallet because of lower gas prices has more incentive to splurge on a Chipotle burrito or a Starbucks coffee.

McDonald’s faces some tough times in the years ahead because of changing behavior. Value investors need to be aware of this behavior if they want to see their investments continue to grow in the years ahead.