Fast Food: It's All in the McDetails

 | May 17, 2013 | 6:00 PM EDT  | Comments
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Stock quotes in this article:

mcd

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yum

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wen

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bkw

McDonald's (MCD) sweats the small stuff. That's why I like this stock as a long-term position and it's how the company delivers an 18.7% return on invested capital.

Among competitors only KFC, Taco Bell, and Pizza Hut parent Yum! Brands (YUM) beats McDonald's on that measure of profitability at 25.2%.

Both Wendy's (WEN) and Burger King Worldwide (BKW), in contrast, show a negative return on invested capital for the trailing 12 months, at -1.84% and -0.39%, respectively.

It's hard to keep up on product innovation, marketing and restaurant "refresh" when you are so much less profitable.

A recent study by QSR Magazine that showed that it was taking McDonald's customers five more seconds to get through the drive in line in 2012 than in 2011, and 37 more seconds in 2012 than Wendy's customers has prompted a big rethink of the menu at McDonald's, according to an email to franchisees obtained by Bloomberg.

The problem, according to the email, is that the McDonald's menu has become so large that it has slowed down service. McDonald's has added 60 menu items since 2007 and the menu now includes 145 items. Among the new items are some that take a comparatively long-time to prepare. A McWrap, for example, takes 60 seconds to prepare -- an age in the world of fast food. It's no coincidence that In-N-Out Burger was the fastest in the magazine survey and also has an extremely simple menu.

You can think of this as a second sweat-the-details front that McDonald's has opened with competitors.

The first was over value menus. Here McDonald's looks like it has taken the best shots from Wendy's and Burger King and begun to claw back share. The 0.6% drop in global same store sales for April that McDonald's reported on May 8 hid the company's progress in the U.S. market. The drop came on falling same store sales in Europe (there's a recession going on) and in the Asia/Pacific/Middle East/Africa region (fears of avian flu kept customers out of restaurants in China.)

But in the U.S. same store sales climbed 0.7%. Part of that growth recovery is a result of McDonald's re-establishing its pricing edge in a tough economy. Historically, according to data from Credit Suisse, increases in McDonald's prices have trailed increases in prices for the fast food sector as a whole by as much as two percentage points. The company lost that edge at the beginning of 2011 but began to reestablish the price gap in mid July. At a one-percentage point difference, the gap isn't back to historical levels but it is moving in the right direction.

And judging from recent quarterly comments from companies such as Wendy's, competitors are feeling the pressure.

The second front -- the menu/time of service front -- is likely to be felt most keenly at Burger King, which with a drive in service time of 201 seconds, was already considerably slower than McDonald's or Wendy's.

McDonald's has had a good run -- 20.4% -- from a local low of $84.12 on Nov. 16 to a $101.12 closing price on May 16. The stock isn't particularly expensive versus its peers, though. On the basis of projected future price-to-earnings ratios, McDonald's sells as a discount to the average multinational consumer stock.

That group, a favorite of investors lately, trades at about 20.5 times projected future earnings against 17 times for McDonald's. I think some of that lag is the odd historical resistance among investors to owning McDonald's when it moves above $100. The shares have struggled to break above/stay above that level since early April. The 50-day moving average is at $100.41 right now and seems to be acting both as support and resistance.

The shares will pay you a dividend of 3.08% as you wait for them to break through this price level.

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