McDonald's: Winning a Hard-Times, Fast Food Fight

At first, bad economic times meant relatively good news for fast food chains such as McDonald's (MCD) and Burger King (BKC), while cash-poor consumers traded down from more expensive dining fare. Now, as the U.S. unemployment rate remains uncomfortably high, chains are struggling to keep Americans eating out at all.

"We have a price war going on," says Morningstar (MORN) analyst R.J. Hottovy. Burger King, McDonald's, and Wendy's (WEN)—which also owns the Arby's chain—are scrambling to offer special promotions and introduce new products.

The advantage continues to go to McDonald's. On Mar. 8 the big worldwide burger chain reported February sales results that beat analyst expectations. McDonald's global sales rose 11.2% in February. Asian same-store sales jumped 10.5%—the most since November 2008—and European same-store sales rose 5.4%. McDonald's shares gained 2.28% to 65.12, on Monday.

McDonald's reported a 0.6% increase in same-store U.S. sales, which came despite cold and snowy winter weather that shaved about 2% off U.S. sales, a McDonald's spokeswoman told Bloomberg News.

Burger King and Wendy's haven't reported February sales figures. On Mar. 4, Wendy's said Arby's January same-store sales fell 7.4%. That's better than the 12.6% drop that Arby's same-store sales registered in the fourth quarter of 2009—an improvement that a company statement attributed to a new $1 value menu. A bright spot for Wendy's: In January, same-store sales at the Wendy's chain rose 0.3% in North America.

"We remain confident [McDonald's] will continue to gain share in the U.S.," said Morgan Stanley (MS) analyst John Glass on Mar. 8. Among growth catalysts are expansion of McDonald's McCafe line of beverages this spring and the introduction of smoothies this summer, Glass wrote.

"relative stability" lures investors

Investors appear to agree that McDonald's is winning this recession's fast-food fight. McDonald's shares are up 10.6% since the beginning of 2008 while Wendy's shares have tumbled 46.4% and Burger King stock has fallen 35.9%. So far in 2010, McDonald's is up 4.3%, Wendy's shares are off 2.1%, and Burger King's shares have dropped 2.7%.

"Investors have gravitated to the relative stability of McDonald's performance," Bank of America Merrill Lynch (BAC) analyst Joseph T. Buckley wrote on Mar. 8.

Size is a big McDonald's advantage. With 32,478 restaurants around the world—57% of them outside North America—McDonald's can seize on such marketing opportunities as the Olympics. Chicken McNuggets advertisements linked to the Winter Games helped boost sales last month, McDonald's said. (Burger King has 40% of its restaurants overseas, while Wendy's and Arby's are almost exclusively U.S. chains.)

McDonald's "is using its marketing scale to emphasize its existing value message," Oppenheimer (OPY) analyst Matthew DiFrisco wrote on Mar. 8. A strong balance sheet and cash flow are helping to fuel further growth, he notes.

Although McDonald's has dominated the competition so far, Burger King and Wendy's are trying to fight back. Executives at both companies have said they see big opportunities to grow internationally. Both chains have promoted value menus.

For restaurants, U.S. economy is key

Despite discounts, fast-food chains protected profit margins in 2009 by cutting costs and taking advantage of lower commodity prices. But with many possible cuts already taken and the possibility that commodity prices may be rising, Wendy's has warned that its costs could rise 2% to 3% in 2010, especially in the last half of the year.

For fast food chains—and the entire restaurant industry—the key remains the U.S. economy's direction. In February, the U.S. unemployment rate remained steady at 9.7%.

Joblessness appears to be squeezing consumer spending, even as the broader economy recovers from recession. The U.S. gross domestic product grew 5.9% in the fourth quarter, but consumption—spending by consumers—rose merely 1.7%.

Standard & Poor's equity analyst Mark Basham notes that results for 2008 and 2009 constituted the first time that traffic at all U.S. restaurants fell for two consecutive years. Last year was the first to record a year-over-year decline in industry sales.

So far in 2010, restaurant same-store sales figures have remained negative, Morningstar's Hottovy says. "To get that [positive], we need improving unemployment rates," he says.

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