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    McDonald's New Value Menu Slow Out the Gate

  • The fast-food chain's stock had a rough week. Will that continue?

    McDonald's new dollar menu has room to grow.

    McDonald’s had a banner year in 2017 by most accounts, but especially on the stock market. When the fast-food giant reported its fourth quarter and fiscal 2017 earnings in late January, shares were trading around $177—up a whopping 44.5 percent over the past year. This calendar year is turning out to be a bit more challenging. On Friday, McDonald’s shares closed the day down 4.8 percent, its worst dollar decline in its history as a publicly traded company (McDonald’s went public in 1965), according to FactSet data and MarketWatch, which tracks back to 1972. It was also the biggest percentage drop since October 2008.

    The week as a whole was McDonald’s worst percentage decline for shares since 2008 and the steepest total dollar decline for a week ever, off 9.1 percent. As MarketWatch pointed out, shares of the Dow Jones Industrial Average component were most recently off 4.9 percent, or $7.67, weighing on the price-weighted blue-chip benchmark.

    What was the culprit? McDonald’s fourth-quarter results were stellar with 4.5 percent comparable same-store sales growth in the U.S. However, much of the messaging lately has centered around value and the chain’s new $1 $2 $3 Value Menu. It appears the offering isn’t resonating to the degree some investors expected, at least not yet.

    David Palmer of RBC Capital Markets cut his expectations “due to deteriorating industry conditions and a disappointing early sales impact from the $1, $2, $3 value menu." Palmer lowered his price target for McDonald’s stock by 9 percent from $190 to $170. The first-quarter same-store sales forecast also fell to 1 percent from 3.5 percent. A FactSet consensus is calling for $3.8 percent growth.

    Palmer’s $170 price target is still nearly 15 percent higher than the $149.27 price McDonald’s closed on Friday, a level not seen since last May. He also reiterated an outperform rating, despite the cut.

    “Our sense is that the $1 $2 $3 platform stole attention from local marketing, particularly at breakfast, which likely slowed as a consequence. In addition, we believe $1 $2 $3 menu’s positioning as a variety play protected franchisee profitability but lacked the ‘hero’ item necessary to resonate with value-conscious consumers,” the RBC Capital Markets analysts wrote.

    These concerns seem to be of the short-term variety. For starters, the future target shows plenty of runway to let additional initiatives kick in or for the $1 $2 $3 Dollar Menu to ramp up as marketing efforts do. Palmer also said tax reform, food-at-home inflation, improving wage growth, and low unemployment should boost traffic and buoy sales throughout 2018. The “hero” item note is worth considering given the rising competition in value. Competitors like Taco Bell (think $1 Nacho Fries), Burger King, and Wendy’s, are all bringing robust value offers to the table. Is there currently an item to get guests to pick McDonald’s over those brands? The company will face heated competition in this arena, no question, but there’s little reason to doubt its ability to innovate the space.

    Chief executive officer Steve Easterbrook said in the fourth-quarter call that: “With relevant menu choices for our most price sensitive customers we have strengthened consumer perceptions of McDonald's as a place to find a tasty and affordable meal. Across the system our markets have increased the range and appeal of our food and real bundles offered everyday at compelling price points.”

    He also commented on the rising competition.

    “With regards to value, it’s a market share fight,” he added. “We don’t see really any significant broader market growth this year. We are certainly not planning on that. So therefore, we know we are in a market share fight and values is where it really does get the street fighting really hits.”

    At the time, Easterbook said it was too early to share results from the $1 $2 $3 Dollar Menu, and that it would take some time to recount. “When you introduce a platform as strong and that's being built upon for the medium and long-term, it’s going to take three to six months for it to fully embed in the minds of consumers,” he said.

    For fiscal 2017, McDonald’s global comparable sales climbed 5.3 percent, giving the company its best sales performance in six years. Systemwide sales were up 7 percent and McDonald’s reported positive guest counts in all segments.

    Comparing comps and stock performance to a watershed fiscal calendar will dilute some results perhaps. Or McDonald’s accelerated investments will take hold sooner than later.

    The company said after the fourth quarter that it plans to invest bout $2.4 billion of capital in 2018, the majority of which will go to deploying the “Experience of the Future” design at U.S. locations, and open about 1,000 new locations.

    McDonald’s credited its fourth-quarter success to “a result of strong performance of core menu items featured under the McPick 2 platform and beverage value, as well as strong consumer response to the new Buttermilk Crispy Tenders and delivery.”

    Will the new value menu result in similar performance in due time?

    As Easterbrook pointed out in the call, McDonald’s is in a power position to leverage its product.

    “In terms of just the muscle we have, I mean one of the changes that the operators in the company signed up to last year was we were going to divert more money from the local agencies, the local costs, into the national marketing cost. And that is A, more efficient in spend, and secondly, gives us much more universal clout,” he said. “So, I [that] really gives us differentiating muscle as opposed to any of our competitors. I think the quality of the lineup and the financial muscle we have through our national marketing program in general we think will remain very competitive on the value add.”